UNCORRECTED TRANSCRIPT OF ORAL EVIDENCE To be published as HC 606-xxx

HOUSE OF COMMONS

HOUSE OF LORDS

ORAL EVIDENCE

TAKEN BEFORE THE

PARLIAMENTARY COMMISSION ON BANKING STANDARDS

BANKING STANDARDS

WEDNESDAY 30 JANUARY 2013

CAROL ARROWSMITH, DAVID BOLCHOVER, ALISON CARNWATH, DR ALEXANDER PEPPER, PAUL SHARMA, SIR JOHN SUNDERLAND and JOHN THORNTON

Evidence heard in Public

Questions 3192 - 3399

USE OF THE TRANSCRIPT

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Oral Evidence

Taken before the Parliamentary Commission on Banking Standards

on Wednesday 30 January 2013

Members present:

Mr Andrew Tyrie (Chair)

Baroness Kramer

Lord Lawson of Blaby

Mr Andrew Love

Mr Pat McFadden

Lord McFall of Alcluith

John Thurso

Lord Turnbull

Examination of Witnesses

Witnesses: Carol Arrowsmith, Vice Chairman and Partner, Deloitte LLP, David Bolchover, Management Writer, and Dr Alexander Pepper, London School of Economics, examined.

Q3192 Chair: Thank you all three of you for coming in to give evidence this afternoon. We are quite short of time, so we will rattle on if that’s okay. May I begin by asking you, Carol Arrowsmith, whether you think that poorly constructed incentives have made a major contribution to poor standards in banking, and if so why?

Carol Arrowsmith: Let me start by saying that my day job is executive pay and I advise major companies and boards, and mostly remuneration committees. I do not actually advise any banks, and have not done for the best part of 10 years, so I am not a banking pay specialist. However, if you look at it from a professional point of view other than as a banking specialist, it is hard to say that it has not made some contribution, but as with all these things disasters tend to have a number of parents until one is asked to own up to being one of them.

Q3193 Chair: Why are bankers paid so much?

Carol Arrowsmith: As I said, I do not advise banks on how bankers are paid. If you look at how the banking pay world has evolved, it has been based on the monetary value that is delivered or passes through the hands of the bank. As banks have got bigger and more global, those numbers have got bigger, and I think the pay has moved alongside that. But it is not my area of expertise to know exactly how banks have chosen to pay what they have chosen to pay.

Q3194 Chair: May I invite Mr Bolchover, and then Dr Pepper, to answer the same two questions?

David Bolchover: First of all, undoubtedly bankers’ pay did contribute to the financial crisis. It is only human instinct that if you have a huge upside reward for taking risk, you will take that risk knowing full well that the worst that can happen to you is that you lose your job in a few years, but you have several million pounds in the bank already. Clearly, there was an imbalance of risk.

Why are they paid so much? Because the bankers and their allies, including head-hunters, recruitment, remuneration consultants and remuneration committees all have a vested interest in high pay, and they have put forward this agenda. They say that only an extremely limited amount of people can do these jobs and therefore, by the laws of supply and demand, their pay should be extremely high. I believe that claim is irrational and is not backed up by proper evidence.

Dr Pepper: I think that pay is an element of a system that broke down and to that extent, it would be reasonable to assume that it had something to do with the breakdown in the system, but it was only one component in a very complicated system. Why are bankers paid so much? My thesis is that since the London securities markets were deregulated in the 1980s, we have seen bankers-employees of securities houses-take an ever-increasing share of the value that those businesses create. I think that is symptomatic of a breakdown in the labour market that supports the London securities industry. To that extent, the fact that there has been a breakdown in the labour market has contributed to the amounts that bankers are paid.

Q3195 Lord Lawson of Blaby: I am not quite sure what you mean by a breakdown in the labour market.

Dr Pepper: Before Big Bang, the City of London was populated by the smaller businesses-many of them partnerships, and others private companies. There was a close relationship between wealth creation and risk. Post-Big Bang, with the consolidation of the industry, the relationship between risk and reward changed, and, I would argue, broke down. A lot of the norms and informal institutions that had contained pay in the City-or perhaps it is better to say, aligned reward and risk better-gradually broke down as well. I think the labour market that supports the industry is flawed, and to that extent, one of the consequences is problems with price-with wages, and what people are paid in that market.

Q3196 Lord Lawson of Blaby: I still do not fully understand what you are saying, but I think you are saying that there was a major cultural shift, as a result of which people with no great ability were able to con others into thinking that they had a great ability. Therefore, they were paid far more than they were worth.

May I say something about my own experience of remuneration consultants? I would like Mr Bolchover’s view, because he has made a closer study of all this than I have. My knowledge of remuneration consultants, which is from a company not in the financial sphere, is that they are a profession that makes prostitution seem thoroughly respectable. When they are brought in, they know that if they recommend low pay they will not get a repeat performance, so in order to ply their trade, they pitch their recommendation as high as they possibly can. This is also convenient for the non-executives, who might otherwise feel awkward in awarding the executives these very high pay levels, because of the cover that it has been recommended by a remuneration consultant. That is how it has worked, in my experience. Does that tally with your experience, Mr Bolchover?

David Bolchover: Obviously, there is a clear conflict of interest. These people are hired by the executives, whom they then recommend to be paid very well. There have been instances, in the shareholder spring, when shareholders have reacted against remuneration consultants. The investors have a crucial role to play in limiting the power of the remuneration consultants, but what they have done in that shareholder spring is to punish any reward for failure-the most egregious examples of reward for failure. I believe that this has to go much further. The investors themselves have a responsibility. They have to investigate the defence that is used-if a company becomes hugely successful, or on the face of it becomes profitable, is that due to the people who work there or to a whole lot of other factors that do not seem to be investigated properly and are underplayed?

Q3197 Lord Lawson: Would you agree, Miss Arrowsmith, with what I said and, more importantly, with what Mr Bolchover has said?

Carol Arrowsmith: I would find it extremely difficult to agree that I have spent 25 years of my life being worse than a prostitute, actually.

Q3198 Lord Lawson: It may be difficult, but it may be true.

Carol Arrowsmith: No, I do not think it is true. Let me explain a few things about what I do. I cannot speak for every consultant in the UK. Perhaps you should have chosen different consultants. My view is that my job is to ensure that companies make informed and intelligent decisions. In the past six months, I have recommended lower bonuses and no pay rises for about two-thirds of the companies I work with, so I take serious issue with the idea that I am hired by an executive to make them more money. I am hired by the non-executives-the remuneration committee-who have to defend, in the public domain and the court of public opinion, what they have decided to pay the most senior people, that is the board members, to their shareholders, the press, politicians and bodies such as this. It is a matter of legitimate public interest what very senior executives are paid. It is a matter of public interest how that process works. It is not fair to say that the whole profession cannot say no to executives. It is simply not true.

Q3199 Lord Lawson: It may not be true in your case. We have never met and I am perfectly happy to accept your word that it is not true in your case. Do you not have at least the faintest suspicion that there are remuneration consultants who have behaved in the way I outlined? I know it to be true, in fact.

Carol Arrowsmith: I cannot speak for every consultant in the land, in the same way that none of us can speak for every member of the profession we happen to occupy. There is absolutely no doubt that everybody involved in environments where people feel that pay is out of alignment needs to think about their own role. That is just as true for remuneration committee chairmen as it is for remuneration consultants as it is for institutional shareholders. I absolutely would not accept that all consultants are incapable of saying no to management. There are a great many, and I do not consider myself to be quite so special as to be the only consultant ever to have uttered the word "no".

Q3200 Chair: Do you think that it is easy for a REMCO to tell the senior executives that they should be in the bottom quartile for pay when you have offered your exemplification of the industry’s comparators?

Carol Arrowsmith: There are two things. First, you have to choose the right sort of information to get a sense of whether you are choosing to pay people appropriately. If you work for a corner shop, you do not want the leading supermarkets in your comparator group, because it is totally inappropriate. Having said that, when you look at it, if you are among the smallest and least successful, it is perfectly right that you should be towards the bottom end of the pay scales; you should not be at the top.

Q3201 Chair: Do you agree that it is very, very difficult for a REMCO to propose bottom quartile pay?

Carol Arrowsmith: I have a number of companies that do. I do not think it is the easiest decision. It is always nice-it is a bit like everything in life-to hand out prizes.

Q3202 Chair: I am trying to get to whether you agree with the widely held perception that comparators, often driven by consultancies, create a ratchet.

Carol Arrowsmith: The biggest single means of ratcheting pay has been the transparency of board pay, because every executive who is worried about pay will have their own database of whom they would like to be paid like. There is absolutely no question but that public disclosure of pay does not reduce pay. It increases it. It did it in the US. It has done it in the UK. What it does do very effectively is improve the shape of pay. For example, the biggest single thing that the substantial disclosure of pay and the binding bonus has done has been to remove three-year service contracts, and therefore reduce significantly the cost of exiting someone who is not succeeding.

Q3203 John Thurso: Can I just prosecute this a tiny bit further? I chaired a REMCO of a FTSE 350 company-much smaller-and it seemed to me that what result you end up with depends on where you get on the circle. In giving advice, when are you normally brought in and what is your start point-who instructs whom, and at what point in the process?

Carol Arrowsmith: Again, I can only speak for my own experience and the way that our firm works, because people use consultants differently. Some companies will simply get a market view and the consultants will have no other engagement-they will just be asked to deliver market data. Other organisations will draw the consultant into a process where the information is tabled and discussed during a meeting, so you have a greater opportunity to express caveats to make sure that what you are saying has been understood. I would say that most major companies would have a consultant available to them whenever they wanted one. In terms of when and how you are brought in, almost without exception now-this is public knowledge; it is in the annual report of most companies-the consultants are selected by the non-executives and most particularly led by the chairman of the remuneration committee. Very few are advising the committee having been selected by the management.

Q3204 John Thurso: What I really want to ask is, it seems that the first decision that the remuneration committee makes is on the policy that it wishes to pursue.

Carol Arrowsmith: Yes.

Q3205 John Thurso: Would you expect to be brought in to advise on policy, or on its execution after the policy has been decided?

Carol Arrowsmith: You have a policy by default, whether or not you have articulated it. It is not a linear process. There isn’t a world, except with IPOs, where you emerge policy-free; you have something in place. Generally, you might go in at some point where the committee has decided that it wants to look at having new advisers, so you go in and hold a mirror up to the organisation and say, "When we look at you, this is what we see. We see that you are this kind of business and you are in this sector. These are the things that you pay for, and this is what you say your strategy is-do they line up?" You might also see a piece that benchmarks and says, "Actually, if you look at the kind of company that you are"-you have to be very thoughtful about who goes into that group-"then you are very well paid or sensibly paid or very low-paid. Is that where you want to be?"

Q3206 John Thurso: Broadly speaking, from what you are saying, everything that the board will be thinking about and considering is likely to be based on a comparator basis. You hold up the mirror and say, "This is what you want, and this is what other people are getting."

Carol Arrowsmith: No, it’s not. There are other dimensions. For example, does it marry with their strategy? Typically, they will set out their objectives, so you are saying, "Are you paying for the same things as you say you value at the front of the annual report? Is that aligned?" The second thing is how it squares up with best practice and the expectations of shareholders-can you see things that would be problematic for shareholders and have they thought about why they have them? Companies are very diverse and make different decisions for different reasons, but they need to make those decisions mindfully and consciously. Choosing to be different is one thing; finding yourself out on a limb when you did not see it coming is not clever at all.

Q3207 John Thurso: One of the things that is very interesting is that if you look at the multiple between the average graduate entry and a CEO over time, it has been rising inexorably. Supposing, as the chairman, owner, or whatever, of a company, I decided out of corporate social responsibility that I wanted to put that multiple back to where it was, and I told you as a consultant that that was our policy. How would you go about dealing with that?

Carol Arrowsmith: Interestingly, I did not do that, but I did something not dissimilar for a company that had come out of being part of a very much bigger company. It did not thrive and its size shrank. I was the adviser who worked with them to reduce their bonus opportunity and share awards so that they were more in keeping with the kind of business that they once were. Like any other challenge, you sit down and work out the cost, partly because if you lose some of your most talented people, you might question how aggressively you want to pursue that strategy and over what time scale. But it is not an unending escalator upwards-that every organisation should somehow pay its board members more than its predecessor did.

Q3208 John Thurso: Can I come to you, Mr Bolchover? You have written about this subject fairly extensively, and you have heard the previous exchanges. To what extent has the considerable movement over the same period towards much higher components of variable pay been a driver in inflating remuneration?

David Bolchover: By variable pay, you mean bonuses and long-term incentives?

John Thurso: Yes, absolutely.

David Bolchover: Are we talking about the finance sector?

Q3209 John Thurso: To cut it short, what I am driving at is that for most of the things that people do in the world-you run a war in Iraq, you do some brain surgery or something-you get well remunerated for your qualities. You may or may not get a little bit extra, but basically you just do the job. Recently, banking has always made the argument, "Actually, I want that big salary, but could I have six, seven or eight times on the top, please, for doing my job?" I am trying to get at whether or not that is worth it.

David Bolchover: If we look at what has happened in the banking industry over the past few years, since the financial crisis, salaries have gone up hugely to compensate for the loss of bonuses, particularly in Europe, where European Union rules now forbid or advise strongly against cash bonuses. We can get fixated by how people are paid and by how executives and people lower down in the finance sector have been made rich. We should really be concentrating on the question of whether they should be made rich when these people have not taken any personal financial risk and it is extremely questionable whether they have a rare talent that should be rewarded in this way and, indeed, whether they as individuals make the impact on corporate performance that they claim to have.

Q3210 John Thurso: You are basically taking the same view as Warren Buffett, which is that, if you go back to the basics of capitalism, capital should earn its reward, labour should have its reward for honest sweat at the coal face and there is no reason why a lot of very overpaid people in the middle should get much more money than anybody else just for doing their job.

David Bolchover: Absolutely. I think that, in the past 30 years-since about 1980-we have lost the sense, at a very fundamental level, of the true precepts of capitalism: that if you take a risk, your business is successful and you improve consumers’ lives in some way, then it is quite right that you should become wealthy, and no one, apart from extreme socialists or people who oppose the free market economy, would be opposed to that. But in the past 30 years, we have seen people with, I believe, no particularly rare talent, who have not taken a risk and whose impact is questionable, capitalising on the fact that they are meeting very little resistance to their arguments.

As was previously mentioned by my colleague, in the financial sector prior to the 1980s, these companies would have been partnerships. They took a bit of risk, and they would take money for their risk and for being an employee, and they sought a way to sustain that wealth despite not taking any risk. The same goes for the top of the corporate world: 60% of the stock market in the 1960s was owned by wealthy individuals. If you had a CEO walk into a room in the 1950s or early 1960s, saying, "Please give me a huge pay rise: I should be a multimillionaire because I have such a rare talent," these people would laugh him out of the room. But who is going to oppose that argument now? Everyone seems to be on their side, right down to the business schools, the financial press, compensation consultants and so on. There is an extremely powerful nexus of interests that are defending that argument.

Q3211 John Thurso: Dr Pepper, is that a set of assertions that you would agree with?

Dr Pepper: No, not at all. One of the problems with the public debate about pay is that it has become far too simplistic. We are talking about a very complex question, and it belies simple statements and simple answers. It belies pointing the finger at components of the system and saying that they are responsible for a breakdown in the system.

I am slightly confused by the discussion, because I thought we were here to talk about bankers’ pay, and we have shifted to executives. One of the problems with the public debate is that we confuse different things. While there is some connection, and banks clearly have senior executives as well as other people, if we are talking about bankers’ pay as a generic problem-

Q3212 John Thurso: I suppose that, in the mind of many, bankers are the bank managers, but you are making the very good point that this is about the people in the bank.

Dr Pepper: But the point I am making is that there are two distinct issues. One is the issue about executive pay and the other is an issue of pay in the securities industry. The public sometimes conflate the two, which is not helpful. If we are focusing on the banking industry, my thesis is that there has been a failure of the labour market that supports the securities industry.

Q3213 John Thurso: Let me put this to you. In a way, this all comes from the previous debate. If you look at many other industries, such as my old industry, it is perfectly appropriate to give people large commissions for undertaking specific jobs or to relate their remuneration to what they do. If you have a general sales agent who is selling things for you, the more he or she sells, the more they earn. That is absolutely perfect. The control of that, however, is in the hands of people who are not also being linked to that action. The management are actually being remunerated and incentivised in different ways, part of which is their reputational risk. In identifying labour market failure, to what extent are you identifying that the executive management controllers need to have a different set of incentives from those who actually undertake trades or whatever?

Dr Pepper: Again, with the greatest respect, I think we are missing the point.

Q3214 John Thurso: Okay. Tell us what the point is.

Dr Pepper: The reason why the labour market has failed is to do with the structure of the industry: the universal bank for which employees work for short periods of time without a level of commitment and without a proper relationship between risk and reward. Those are the issues-

Q3215 John Thurso: You are talking about the teams who move en bloc from one-

Dr Pepper: Absolutely, but more to the point I am talking about the structure of the banking industry. If some of the reforms that have been talked about in recent months-the Vickers report and so on-about drawing a distinction between different types of banking activity go ahead and if, to go a bit further, the securities industry finds ways to recreate some of the informal norms that existed in the old days when those kinds of banks were partnerships, that is a way to solve the problem that we are discussing.

Q3216 Mr Love: A number of witnesses who have come before us have suggested that we ought to change the compensation structure and that one of the issues is whether we should shift from return on equity to return on assets as an alternative set of metrics to promote a longer-term outlook in the banks. To what extent is that happening? Will it happen more in the future?

Dr Pepper: I am afraid that this is dealing with the symptoms not with the cause. People have been fiddling around for years with the technicalities of long-term incentive plans and how you assess performance. We just move from one set of problems to a different set of problems.

There is a principle in cybernetics systems theory that says that for every potential shock in a system you need a potential response. If you translate that theory into pay systems, that means that every type of issue that somebody might face in their work needs some kind of response to it in the pay system. That creates a degree of complexity that baffles people. The trouble with all this discussion about forms of measurement, risk assessment, risk-weighted assets and all that kind of stuff is that we are dealing with the symptoms, not the causes.

Q3217 Mr Love: I will come back to you about the longer-term nature of dealing with the causes, because, in a sense, the reason why we are dealing with the symptoms is that they can be done in the relative short term. Mr Bolchover, do you agree with Professor Pepper?

David Bolchover: Absolutely. Actually, the added complexity of measurement and of the different forms of long-term incentives play into the hands of those who wish to sustain the current system, because everything becomes so baffling that it is difficult to argue against.

Q3218 Mr Love: Coming back to you, Professor Pepper, what would you suggest we do to address the remuneration issues and deal with the longer-term cultural issues you are talking about?

Dr Pepper: You cannot deal with the remuneration issues without dealing with structural issues in the banking industry. As I say, I see pay just as a component in a bigger system. One of the things that have gone wrong is that people try to tackle pay and solve a technical problem, as they see it, when the issue is a more systemic one.

Q3219 Mr Love: But don’t you think that what is being suggested to try to get people to think more in the long term-deferred remuneration is another issue we have been looking at-although it might not be dramatic and revolutionary, it contributes to addressing the real public concerns that there have been about excessive remuneration?

Dr Pepper: Again, with the greatest respect, I am afraid I do not. I think it is fiddling with symptoms and not addressing the cause. Let me give you a little example of what I am talking about. In the United States in the late ’80s, I think, they tried to put a cap on executive pay by saying that pay over $1 million was not deductible for corporate tax purposes unless it was performance-related. A consequence of that was that all chief executives in America had their pay moved up to $1 million, because they suddenly saw that as the benchmark-the floor, not the ceiling. I think if you force companies to defer parts of the pay that they give to people, you are fiddling with the symptoms and not addressing the cause.

Q3220 Mr Love: May I turn to Ms Arrowsmith, and ask her whether any of these changes that have been suggested-deferring pay over a longer term or using risk-adjusted metrics-will make a contribution to restraining pay and making it more in line with the performance of the bank?

Carol Arrowsmith: I think some of those things will contribute. I absolutely endorse what Professor Pepper said, however. Remuneration is not a remote control system for the organisation. It is no substitute for good governance and good management; it needs to go alongside it. The challenge is thinking that somehow if you fix pay, it will fix the system for you. The reality is that it will not. It is undoubtedly part of what creates the culture, but the culture is something that comes from the expectations around the business.

One thing that I think will help is a reduced focus on a single measure, because the trouble with any single measure is that you can work an organisation to win on that measure at the long-term expense of the health of the business. Oversimplification on a single measure is unhelpful. Concentration on not only how much the business makes but how it makes it is important, because that is a huge part of the sustainability of your ability to make money. We are seeing in one of our leading banks now a focus on the culture and the kind of bank it wants to be, and being very explicit about values. I think that is a really important piece to go alongside pay.

Do I think just deferring pay makes a difference? No. Some of the banks that collapsed at the time of the crisis had some of the biggest shareholdings by executives and people who worked in the bank, and that did not stop them taking those risks. In a sense, if you think about the way it works in a lot of banks, as I understand it, the amount of bonus that you can earn is based on the activity that you do. The use of shares is then simply the currency in which it is paid. If I said to you, "I am going to pay you in Canadian dollars because it will make you feel more like a Canadian," I think most of us would say, "I’m just going to be worried about the exchange rate risk, so I need more Canadian dollars, because my gas bill is going to come in next month and I need to be able to pay it."

I absolutely endorse what Professor Pepper says. There is not a simple thing that says, "If you do this, all will be well." It is important to make sure that people do not get too much, too soon, however, and that there is a period of time where there is an opportunity, essentially, to readjust. A lot of the problem that I have seen in banks is that you have short-term profit at the expense of long-term cost. So you need something that allows for that to be measured, but taking it away isn’t the answer. It is slightly more gratifying than letting them keep it, but taking it away is after the event. What you are looking for is trying to prevent those problems: prevention is better than cure. So having people with the right set of cultural expectations and having what I think now are much better informed non-executives who are much more aware of the risks that they face stepping into the cauldron of being on a bank remuneration committee; bringing risk into the conversation that talks about the extent to which the bank’s balance sheet has been used in ways that are appropriate or not appropriate; all of those things reduce the likelihood of some of the collapses.

If you look back over time, one thing you can see is that every financial system has had its crises. From the tulip bulbs of the 17th century in Holland, there have always been moments of stress. This is the biggest, simply because it is more global, more technology enabled and more dissipated. But human beings are human beings and what in many ways controls them are the expectations about how to behave.

Chair: One quick question.

Q3221 Mr Love: The question may be quick, but I am not sure about the answer. I want to come back to Dr Pepper. One of the things that we have to think about is any changes that we make now when we are in a completely different set of economic circumstances from those we were in certainly before 2008 and from those we may be in in 10 or 20 years’ time. It worries us intensely and it is something we focus a great deal upon. You have talked about structural change being a major contributor. I assume that the other form of change is cultural. Exhorting bank boards of directors to do better won’t contribute. How do we achieve that cultural change that would be necessary to address the remuneration issue?

Dr Pepper: You are absolutely right. It is quite interesting to observe-and I have no direct relationship here-what is happening at Barclays and how the new CEO is clearly trying to set about fundamentally changing the culture, but also recognising that it is a complex thing and takes a very long time to bring about, if indeed it is possible at all. But the point I would make is that if you align structure and try to find ways of aligning risk and reward, there is a chance that good cultures will develop as well.

Q3222 Lord Lawson of Blaby: Dr Pepper, just for clarification. You keep talking about structure and I strongly agree with you, but the only example you have given me is the Vickers ring fence. Is there anything else on the structural front that you have in mind when you talk about structure? If a major cultural change is required, that may be very desirable, but that alone is unlikely to be enough.

Dr Pepper: I wonder why very highly paid people have all the same employment rights and employment protection as people on low pay? The idea of limited liability in an employment relationship if you are a nurse, a cleaner or a teacher is clearly very important. The idea of limited liability in an employment relationship if you are a highly paid investment banker seems to me rather questionable. I believe that one of the possible answers here is redesigning the relationship between highly paid employees and the organisations that they work for, such that they bear more of the risks that they take on behalf of their employers.

Q3223 Mr McFadden: Mr Bolchover, you have written on the question of the talent ideology. This idea that these are exceptional people is continually used to justify these exceptional levels of reward. Is that right?

David Bolchover: Absolutely. This is key to the whole defence.

Q3224 Mr McFadden: Your belief is that they are not exceptional.

David Bolchover: I believe that there are no clear evidence-based reasons for us to go along with that statement.

Q3225 Mr McFadden: Why are banks so unwilling to test that theory? If a trader who is in line for a bonus of x says, "I don’t deserve x. I deserve x + y," which we hear happening quite a lot, why do banks not more often say, "That’s fine. The door is over there if you don’t want to accept x"? Why do they cave in to this pressure so much?

David Bolchover: The trader who wants x + y has a boss who wants 2x + 2y. He says, "This guy who works below me is so talented. Please"-to the guy above him who earns 3x + 3y-"we can’t lose this guy. He can’t go to a competitor. And guess what? I am his boss, so, by inference, I must be even more capable and talented than him. So don’t lose me either."

Q3226 Mr McFadden: What does that chain, which goes right up in the way you described, do for culture and behaviour in these banks? What relationship does it have to the overall behaviour of the institutions and, indeed, the whole financial system?

David Bolchover: Any huge company is just the aggregate of individual decisions on a daily basis. These decisions are hardwired into the system. They create the system. If you have all these individuals who want to become wealthy without taking any risks, the system of high pay will become cemented unless very powerful external forces are brought to bear against them.

Q3227 Mr McFadden: Dr Pepper talked a moment ago about Barclays’s attempt to bring in culture change. The chief executive there is rumoured to be in line for a seven-figure bonus only months after taking the job. What do you think the internal and external interpretation of culture change at the bank will be if that bonus goes ahead?

David Bolchover: I think Professor Pepper means that this will be a long-term cultural change. It seems obvious to me that an individual should not be rewarded when he has been the head of a division where such mistakes were made. That seems so obvious that it is not worthy of debate. Actually, I think this debate plays into the hands of those who wish to sustain high pay. They might go along with this idea and say, "Yes, we shouldn’t reward failure." Several institutional investors have said that we shouldn’t reward failure. But what happens if the company makes huge profits, like they all did 10 years ago? Then they became hugely wealthy. Should those individuals have become wealthy as a result, when it is clear, in retrospect, that what caused those companies to be so successful were benign economic circumstances?

Q3228 Mr McFadden: What you are really saying is that the shareholder spring revolt only addresses part of this problem. It doesn’t actually focus on the main issue.

David Bolchover: Absolutely. I think the whole argument is fixated on reward for failure. Politicians, I have noticed, have made several angry statements about it. I believe that that is not only missing the point, but playing into the hands of the current system. We should be asking whether a company is, on the face of it, successful. However, it is very difficult to find an incorruptible definition of what constitutes corporate success. For example, is a company that makes a loss successful if its competitors make more of a loss? We need to concentrate on that key issue. Are they, as individuals, making an impact on corporate success or failure? If we can make a good case that an individual is making a big impact on corporate success, we need to ask how likely is it that they can be relatively easily replaced.

Q3229 Mr McFadden: Dr Pepper, you have said that a lot of the debate on this issue is focused on symptoms, not causes. What do you think the cause is, and what do you think the cure is?

Dr Pepper: The cause of what?

Q3230 Mr McFadden: The cause of the excessively high pay culture at the top end of investment banking, in particular.

Dr Pepper: I run the risk of repeating myself, but I believe that in the last 20 years in the United Kingdom, the labour market for people who work in the securities industry has broken down. It has failed. That is a consequence largely of structural changes in the way in which the banking industry is organised.

Q3231 Mr Pat McFadden (Wolverhampton South East) (Lab): I don’t really know what that means, I’m afraid.

Dr Pepper: Before the City was deregulated in 1987, the roles of different parts of the securities industry was very well defined and the organisations that performed them tended to be partnerships or private companies. So there was a close relationship between the rewards that the most senior people got and the risks that they took.

Q3232 Mr McFadden: So it is skin in the game.

Dr Pepper: Skin in the game. The key here is the relationship between reward and risk. Personally, I have no problem with people being highly rewarded if they take high risks. Successful entrepreneurs earn huge sums of money, but they take huge risks. The problem in people’s minds with banking and executive pay is that they believe the relationship between risk and reward has broken down and I would agree with that.

Q3233 Chair: On the skin in the game point, do you think that one could, for example, disincentivise firms from attracting fines for poor conduct by ensuring that fines are deducted from bonus pools, perhaps one for one, or an even more punitive ratio?

Dr Pepper: Possibly, but why not pass on fines to the people who have carried out the behaviours that have incurred the fines in the first place?

Q3234 Chair: That, of course, is what should be done but it is very difficult. If we are trying to change the culture of a bank, we need to change the culture of the people around those who are committing the misdemeanours as well as the culture of those who committed them.

Dr Pepper: I understand what you are saying. It is difficult to do with the way that wider employment relationships are currently structured, so why not change it?

Q3235 Chair: I am asking you: we are looking for advice. I will move along the line. Carol Arrowsmith, is there anything in that thought which has been put to us?

Carol Arrowsmith: I think accountability for wrongdoing is important. Simply taking it through into bonuses-and I have looked at this in a number of industries-the danger is that you discourage whistleblowing so that the problem does not come out early enough. It just accumulates and gets bigger.

It is more important that you have an opportunity to align the risk with the individuals. If you look across the corporate world-a lot of this has come from the issues in financial services-the piece of deferred pay allows you to reclaim stuff when it is patently obvious that what went into the system is not justified by what continues to happen.

Q3236 Chair: Let’s give an explicit example. Take people on the trading floor sitting all around those who were corrupting the LIBOR market, many of whom probably had a pretty good idea of what was going on, and certainly could easily have found out. They did not seem to have much incentive to try and find out whether the people sitting next to them were corrupting that market. But if their bonus pool would disappear, and if there was clawback on their bonus pool, perhaps they might. What I am suggesting is: can we devise some form of self-policing in the bonus structure?

Carol Arrowsmith: I think the way organisations go about self-policing is firstly to make sure that whistleblowing is seen as a valuable contribution to the culture of the organisation, so that if you know that something is going wrong, you have a reason to say so. That is almost the way of getting people to get there before the fine. By the time the fine arrives, the shareholders’ money or the taxpayers’ money has left the building, so it is trying to get people to respond appropriately at the beginning.

Secondly, it becomes important that people see, so that, in the same way as people were put in the stocks in mediaeval times, you see that the perpetrators of crime get to pay for the crime. It does not have to be imposed on the bystanders, who may be more or less complicit in it, and if they are complicit in it, they should absolutely be part of the group that gets penalised. To have the point where essentially your pay is determined by your postcode is unhelpful, so it is proximity to the people who committed-

Q3237 Chair: But your pay is determined partly by your own performance and partly by the performance, or non-performance, of your colleagues.

Carol Arrowsmith: Which would be perfectly normal.

Q3238 Chair: I am suggesting that, while that is true on the upside, it might also creatively be imposed on the downside.

Carol Arrowsmith: I would expect that to be relatively normal. In most industries, you would expect that there should be an element of your pay-positive or, in very unusual circumstances, negative-that is a function of you, your team and the organisation.

Q3239 Chair: Let’s have a quick word from Mr Bolchover on this. He is catching my eye.

David Bolchover: Absolutely. Most departments are paid for both individual performance and team performance anyway. Again, to place yourself in the position of an individual, to make this a lifelike position, if you are in line for a large bonus, you might get whispers of something untoward going on in the rest of your team. Are you going to squeal? I would doubt it, because you can always say, "Listen, I didn’t know anything about it. Nobody else is doing anything." Legally, you would probably be in quite a good situation, so you would say, "I will go for the multi-million pound bonus." I think that’s the way most people would behave in that situation.

Q3240 Lord Turnbull: I declare an interest as chairman of two REMCOs.

I don’t share Nigel Lawson’s characterisation of the role of remuneration consultants. I think REMCOs and boards have to take responsibility. Remuneration can sound like a "bad workman blames his tools" problem. My experience is that some of the best advice you get from advisers is, "Well, you won’t get that past shareholders."

I think the more difficult theme is: who does a head of HR work for? Do they work for you, as a REMCO, or do they work for the executive? I would say that that was the greater conflict of interest.

Carol Arrowsmith: I would agree entirely. I think you see them in both shades. There are those who absolutely work for the CEO and those who take what is a difficult and lonely place to be at times-working for the committee-because they still are part of the executive team. It is one of the most challenging jobs when it comes to debating pay. It is one of the areas where I think shareholders underestimate the importance of the committee having access to some form of verification, where they can discuss it with the HR director and with their peers or adviser, to ensure that they are comfortable and that they know what they have from time to time. It is very hard.

Q3241 Lord Turnbull: Mr Bolchover, I do not quite buy the argument that executives were not taking risk. What is interesting-and, as someone said, inexplicable-about many of the big US investment banks, and the US banks that were mimicking them, was that their senior executives held large quantities of shares, often buying more than they were required to under various schemes. So they had tens of millions-in some cases, hundreds of millions-of dollars at stake, yet they still ran these extraordinary risks. I think we have to explain why they did that, because it also tells you something about simply asking people to buy shares and hold them longer. It did not really work first time round, so why should it work second time round?

David Bolchover: They were able to buy such a large amount of shares because they were paid so much in the first place. Their original pay was not based on any risk. We all make commercial decisions with our investments; some go wrong and some go right. But to compare the chief executive, who is paid millions and millions of pounds and invests some of the money he is paid into his own company, when he has not previously taken any financial risk, with the real entrepreneur, who is the sort of person who runs your local hair salon or restaurant and puts everything on the line-their house, their car, the lot-is ridiculous.

Q3242 Lord Turnbull: But if you have $100 million invested in this company, irrespective of where you got it from-

David Bolchover: But that is the point. The money they have invested was based on risk-free wealth, which was obtained, in my opinion, irrationally.

Q3243 Lord Turnbull: But they still had it, and at the point at which they are taking decisions, they are then faced with risk, but nevertheless-

David Bolchover: We all face risk with our investments.

Q3244 Lord Turnbull: Yes, but I would not risk saying goodbye to $100 million dollars very easily. It seems to me to indicate, and this is where we might agree, that the solution is not simply to defer more and more of this into shares, because I suspect that the causation works the other way round. Dick Fuld, in the end, was paid so much that he began to believe that he was infallible. It was not that he was taking risks knowing that there was no symmetry to it; it was just, when people told him that there were risks, that he did not believe them. So he was misjudging the risk. All sorts of parts of our accounting system fed that view, such as the way in which unrealised mark-to-market gains were the basis of remuneration, and led him to believe that he had produced this huge wealth.

The other factor is: why did the shareholders, by and large, cheer him on? I am sure it is like a football club. You may think it is mad to pay millions for a striker, but most fans egg the chairman on. The shareholders say, "I am prepared to do this because I believe he will produce extra value for me," even though, collectively, it cannot be true for the whole sector.

David Bolchover: I am glad that you brought up the sporting analogy, because in the case of a top sports star, their pay seems rational. It is measured according to very transparent, market-based principles and we can see on our television screens every week the impact and replaceability of a top footballer in a way in which we cannot here. Institutional investors and various supporters of these people in positions in top companies will often reduce-you will hear this even on radio and TV-the performance of a huge company to the third person singular: "He has increased profits by £200 million," or, "He’s has increased returns," without, to me, any rational justification.

I was glad that you mentioned Dick Fuld, because is not just financial risk that executives face, particularly in the high-profile financial industry, but reputational risk and career risk. Two people have suffered reputational and career damage from the financial crisis really badly: Dick Fuld, the fall guy in the United States, and Sir Fred Goodwin here. A lot of the other people in such positions whose companies had to be bailed out or suffered terribly in the financial crisis went on to other very high-profile positions.

Q3245 Lord Turnbull: Are you saying that Goodwin did pay a penalty or did not pay a penalty?

David Bolchover: Did he pay a penalty?

Q3246 Lord Turnbull: He obviously left with a lot of money, but otherwise his reputation is completely and utterly trashed.

David Bolchover: Exactly. He was unlucky, in my opinion, because it could just as easily have been somebody else.

Q3247 Lord Turnbull: In which case, there was a risk in his case.

David Bolchover: Exactly. There is a reputational risk, but it is extremely minimal when we think that a large number of companies are involved in this financial crisis, and there was only one fall guy in the United States and only one fall guy here.

Chair: I think we had better bring this session to an end-not because it is not interesting, but because we have got three more sessions to come, so we have got a heavy afternoon. Thank you very much indeed for coming to give evidence. If you have further thoughts in the light of what you have heard, or what you hear subsequently from other witnesses, if you stay, we would be very grateful to have those in writing.

Examination of Witness

Alison Carnwath, former Chair of Barclays Board Remuneration Committee, examined.

Q3248 Chair: Thank you very much for coming to give evidence this afternoon. You have also given us a very interesting little submission.

First, it might be helpful if we have from you first hand what happened in the setting of Bob Diamond’s pay. Perhaps we could start with you telling us how, in the case of his pay, you initiated the process, or it was initiated for you, and then how it was taken through to the point where you were in a minority of one.

Alison Carnwath: The pay recommendation for the annual bonus for 2011 and for the awards that could be given under the then long-term incentive schemes-that is, those matters that had to be decided on before the year ended and the publication of those results-came from the then chairman of Barclays. That would not be abnormal in my experience on boards. He would then consult the chairman of the remuneration committee, or possibly in other places he might have had a consultation before he arrived at the number.

In the first instance, they were recommended by the chairman. He and I had a number of calls on the subject, and I was amazed at his recommendation. I am not normally amazed at what chairmen do, but I was amazed at this recommendation because I thought it was the wrong recommendation. I thought, for reasons I have given in my submission, that it would have been best if the annual bonus for the year had been zero. The environment, the returns from Barclays and the leadership example he could have set all suggested to me that he should have been willing to accept a zero bonus for that year.

Q3249 Chair: A key sentence in your written evidence is, "Barclays returns…were not good from a shareholders perspective with the key measure of ROE…not covering the cost of capital and the share price and dividends showing poor returns."

Alison Carnwath: That’s right.

Chair: It’s pretty comprehensive.

Alison Carnwath: Yes. I thought it was a very simple explanation and justification for my view.

Q3250 Chair: Okay. Tell us what happened when you got into the REMCO meeting.

Alison Carnwath: There were a number of conversations in corridors, as you can imagine. One or two people were a little surprised. A number of people phoned me specifically. I think there were two major concerns. First, it is my belief that a lot of people felt that Mr Diamond needed to have this bonus. That was important to him.

Q3251 Chair: Because he was a vital part of the whole operation? Irreplaceable?

Alison Carnwath: A vital part who needed recognition in this sort of way.

Q3252 Chair: Exceptionally talented?

Alison Carnwath: He had proven to be very talented at building up BarCap-there is no doubt about that-but we were talking about an annual bonus here and a bonus incentive for him going forward as chief executive. I would not take away anything at all that Mr Diamond achieved historically in terms of his capabilities, but it was his first year as chief executive and, for the reasons I have given, I just did not think it was appropriate.

Q3253 Chair: And in this meeting you put forward your proposal.

Alison Carnwath: Yes, and there was disagreement. I think it is fair to say that there were people who were sympathetic to my point of view, but generally tended to go with the chairman. So that was how matters were left until the board meeting, at which the subject was discussed again. This was unfortunately, as everybody knew, a board meeting I was not able to attend, but the chairman was, I believe, extremely fair in putting forward my point of view. Nevertheless, my point of view did not prevail.

Q3254 Chair: You decided to resign very shortly afterwards, did you not?

Alison Carnwath: I resigned on 26 July, and these conversations were going on in January and very early February.

Q3255 Chair: So 26 July. And in between those two events, did you get the feeling that it might be a good idea if you moved on?

Alison Carnwath: I hope I am not being presumptuous here, but I did not actually get that feeling from any of my colleagues. Notwithstanding the disagreement that we had had over this particular matter, with subsequent reaction to his original bonus communication to the market, and subsequent discussions that took place more generally after the AGM about Barclays pay, my recollection is that these discussions were leading to some common sense arriving and a more general feeling that Bob was going to see some more realism. In fact, my recollection is that shortly before he resigned, he had agreed to waive his bonus for the year that has just ended.

Q3256 Chair: So he arrived at your recommendation via a different route.

Alison Carnwath: A completely different set of circumstances, because his agreement to give up his bonus for 2012 was based on the LIBOR revelations.

Q3257 Chair: I just want to know whether you felt under any pressure at all to resign.

Alison Carnwath: No, I did not feel under any pressure to resign. I am quite clear about that.

Q3258 Baroness Kramer: If I may broaden it out a little from the specifics, we heard from one of our earlier witnesses that governance and leadership might be the most key elements in creating corporate culture. What is your view on the extent to which what you are paid for, how much you are paid and how you are paid it has an effect on the corporate culture?

Alison Carnwath: Are you talking about employees of Barclays?

Baroness Kramer: If that is the primary banking experience, that would be appropriate.

Alison Carnwath: Or are you talking more generally about how pay affects people’s behaviour?

Baroness Kramer: I am more interested in the banking world, because that is where this Commission is focused. It does have some conditions. Based on your experience, did you think in terms of the impact on the culture as you were looking at these issues, or was it essentially looking at performance and saying, "That is appropriate"? Was it part of the framework to think what the impact would be on future behaviour as much as on reward for the past?

Alison Carnwath: I understand where you are coming from now. I apologise that I did not at first.

I think I say in my submission that over the years in financial services, a sense of entitlement has emerged among many-not all-of the staff, and that would be particularly prevalent among those who were in the investment banking part of Barclays, or had been in that part. These people, I might add, generally worked extremely hard. I have described how the pay in some instances reached obscene levels. Whether it really affects their behaviour in terms of whether they take more risks, I think that for some it does-for those who have capital that they can use-but this is well monitored at Barclays. They have good policies and procedures on risk. Obviously, there are always those who try to get round those, and they have to be disciplined and dealt with.

People who were in investment banking positions and knew that they could earn a lot of money would work very hard and would try their hardest to make a lot of money for the bank and for the shareholders, but also for themselves. I do not know whether I am answering your question. There is some cause and effect, undoubtedly.

Q3259 Baroness Kramer: Lord Turnbull was talking earlier about the sense of infallibility: "I am so extremely well paid. That must be because I am an extraordinary person and therefore I cannot make a mistake." I do not know whether there was a sense of that so that the risk process was more a matter of form, rather than a challenge. Is that fair?

Alison Carnwath: Possibly, but the risk management was quite sophisticated at Barclays. Historically, it had been picked out as pretty well advanced in terms of how risk management can go, but I think you are right. If people get paid a lot of money, they feel entitled to it. They feel that they can rise to any challenge. They become perhaps over-confident. That is not to say that if you decided to pay them half of what they are paid, they would not be perfectly happy to work for Barclays as well.

Q3260 Baroness Kramer: Could I just ask you what other measures-again, looking at Barclays-came into the picture, other than just hitting some revenue target? Did you have factors such as the more behavioural things and the relationship with the regulator, or some sort of citizenship or social perspective? Was any of that part of the package or the thought process?

Alison Carnwath: When you are looking under the bonnet and you look at the way that senior executives appraised and assessed their staff-that is what led to the bonus levels and the pay levels generally-they would look at misdemeanours in compliance, in risk, or in internal audit, where they were able to identify individuals or teams who had not behaved properly. In terms of behaviour, if people were not behaving as they were expected to behave, in Barclays people would get ticked off and it should affect their pay. On the committee, we could not look with such granularity a long way down the organisation. We looked at people who were paid a lot of money. We looked at them carefully, but they had a process and they tried to deal with this. Then you have to say, "Well, did the managers who were doing this do their jobs properly, or were they too minded to look at market-competitive breaks and say that we have to pay these people x or else they will disappear to JP Morgan or Goldman Sachs?" There was a lot of that, too.

Q3261 Baroness Kramer: I will just follow up with one last question. As you say, you were looking just at the senior executives, but were you looking at the pay structures below that-at least as a structure?

Alison Carnwath: Yes, we had access to that. We knew exactly how the bonus schemes worked in the various parts of the bank. Whether it was the retail bank or wealth management, we had complete visibility.

Q3262 Baroness Kramer: Did you try to bring some of those other factors into that level?

Alison Carnwath: We focused on questions, and tried to ensure that compliance, risk measures and internal audit-things that probably would have been reported to other committees-were taken into account. I would talk to the chairman of the risk committee. I would talk to the chairman of the audit committee. I would talk to the people who were running the businesses. But-as you say this to me-we did not sit down and go through individuals below the top, say, 150 and ask these sorts of questions: good behaviour, bad behaviour, decent citizens. We did not do that, no. I know that trying to understand behaviour and finance together is a subject of great interest, and to me, too, but I must tell you that my starting point is that you just expect people to behave properly, and clearly what has gone very wrong in some of the financial services world is that people have not.

Q3263 Mr McFadden: Ms Carnwath, I want to take you through some of the things in your statement to us. You referred a moment ago to the issue of obscene levels of reward. You said that there are obscene levels of reward in a minority of cases and excessive reward in many cases. Is your starting point that the culture of reward is excessive in banking, at the top end?

Alison Carnwath: I think it has reached those levels, yes.

Q3264 Mr McFadden: How could that influence your position as the chair of a REMCO. If your starting point is that we are at obscene levels of reward for some, and excessive levels for many, and you are charged with recommending pay and bonus levels, it is bit difficult to start by cutting them, isn’t it?

Alison Carnwath: Well, that is what we did effectively in the year I was chairman of the remuneration committee. With everybody’s agreement, we brought down the bonus levels by about 30% in the investment bank. At the end of the day, these all have to be performance driven.

Q3265 Mr McFadden: But are they?

Alison Carnwath: No. They are not only performance driven.

Mr McFadden: Elsewhere in your statement, you talk about the pay culture. You say, "I am referring to Mr Diamond not Mr Jenkins-Mr Diamond was reluctant to do this"-that is, exercise restraint-"and reluctant to accept pay at Barclays was high particularly in the investment bank. The market however knew Barclays were good payers and Mr Diamond himself was well known for his own attitude to reward." Can you tell us what exactly you mean by that statement?

Alison Carnwath: I can. I had hoped that it was self-explanatory.

Q3266 Mr McFadden: It is pretty self-explanatory, but I was trying to draw you out a bit more.

Alison Carnwath: Those of us who have been working in the City would know that Mr Diamond had always enjoyed a generous pay packet. I really believe that he thought he found loyalty in people around him by paying them very well-in my view, more than he needed to.

Q3267 Mr McFadden: Just remind us: you conclude by saying that you disagreed with the board’s recommendation on Mr Diamond’s annual bonus for 2011. You recommended zero. What did the recommendation come in at, in contrast to your recommendation of zero?

Alison Carnwath: It came in as three quarters of what he was allowed to earn. Barclays will correct me if I am wrong on that.

Q3268 Mr McFadden: What is that in pounds and pence?

Alison Carnwath: Several million. An annual bonus of £1.72 million, something like that.

Q3269 Mr McFadden: You say that "shareholders were quite clear on the need to reduce pay at Barclays and this message was communicated in no uncertain terms to the Chairman, the company secretary, the HR personnel, myself and Mr Diamond."

Alison Carnwath: Yes.

Q3270 Mr McFadden: Why did it fall on such deaf ears? What does the fact that it did tell us about the tone from the top that we hear so much about from Barclays?

Alison Carnwath: I repeat that pay in certain quarters of Barclays did come down, but certainly a group of shareholders felt that pay should come down more. Regarding Mr Diamond’s own pay, I think there were some shareholders who probably would have been quite happy to see him paid something, and indeed he was going to be paid something. If you remember, there were some negotiations that went on subsequent to the announcement of his annual bonus, and that resulted in that bonus effectively being deferred and having certain conditions attached to it. There were some adjustments made, but I think some shareholders would have been happy to see him paid something.

Q3271 Mr McFadden: Fast forwarding to today, Barclays have told the world that they are engaged in an enormous culture change exercise. There was an e-mail from the chief executive to all staff a week or so ago, saying that anyone unable to handle this may need to leave, and that they are very genuine about change. There has then been news within the last 24 hours that he may be in line for a seven-figure bonus, within months of taking up the job. What do you think that level of bonus for him will say about that e-mail or the wider exercise of culture change at the bank?

Alison Carnwath: Well, I think one would have to look also at what the returns are like for Barclays this year. I have no idea, because I am no longer there. One would have to look at what the performance has been at Barclays.

Mr McFadden: You are being very diplomatic.

Alison Carnwath: It is not normally a strength. In many other industries which have been suffering-I can give you an example. This is not financial services, but I am chair at Land Securities, and in a difficult year there was no question of any of the top people being paid any bonuses. I have an expectation that until such time as returns are more normalised at the banks, and Barclays in particular-which they will be, one day-real leadership is shown by declining bonuses. These people are quite well paid anyway.

Q3272 Mr McFadden: What I am driving at, and I want to finish on this, is that we are interested in culture. At Barclays, probably more than any other bank, we are told about tone from the top. I am afraid I cannot help but draw the contrast between the action implied in a bonus of that size and all the e-mails and press releases that were issued.

Alison Carnwath: In this matter I am inclined to agree with you.

Q3273 John Thurso: I want to focus on the remuneration committee in theory, leaving aside your particular experience at Barclays, although I assume you have had experience of other remuneration committees.

Alison Carnwath: I have, yes. I sit on three.

Q3274 John Thurso: I am interested in whether or not the remuneration committee construct in corporate governance at banks can actually do what we fondly believe it ought to. Would you take me through the cycle of decision making, from any point on that circle in the year that you like? How do you start to build up the picture, who is talked to, what advice is given and how do you arrive at the eventual-what you might say would be best practice, and what actually has been your experience?

Alison Carnwath: I think there was best practice in many regards at Barclays, by which I mean that it had an HR department that was pretty objective and impartial, external advisers who gave market input and a committee with some competent people on it that was always well attended by both management and non-executives. The framework was there.

Early in the year, we would, with hindsight, take a look at how pay had worked out compared to our competitors to see whether we were on the right track-whether we had been overpayers or underpayers. We would take a look at whether people had left the bank, because often they would leave if they were not paid properly. We would take a look at general pay trends. We would have an early sight of the bonus accrual that was going through the quarterly numbers. We would take a look at what costs were being taken out of the business and we would look at the financials carefully in that regard. We would be well informed with a lot of objective data. We would also have conversations with our colleagues in risk-both in risk management and on the risk committee-and audit, if there were particular incidents that were causing concern. PPI would be a good example while I was there; it caused considerable concern and cost the bank a lot of money.

We discussed this over four or five meetings during the course of the year. Recommendations would begin to come forward, which we would discuss. We were not faced, as you are in some organisations, with bonus arrangements being put in front of you at the last moment and you have to make a decision; we were given some guidance as to where bonuses were likely to end up towards the end of the calendar year. Our input was, on some occasions, listened to. My mantra, as I think I cited, was that costs had to come down at Barclays and pay had to be part of that, and Mr Diamond certainly knew that I was perhaps more determined than others had been-question-to be a bit more aggressive in trying to get pay down.

The committee worked in a pretty normal way, but to my mind, it was going to take time to end up with the right result, which was to reduce pay levels-

Q3275 John Thurso: I am being pushed for time. I am grateful for that, as it was necessary to establish. I have chaired a much smaller REMCO-

Alison Carnwath: They can be worse.

Q3276 John Thurso: Tell me about it. The key question is this: you have just described what could be said to be the optimum operation of a big plc REMCO, and yet it was a complete car crash in terms of the result. Do I infer from that that the model is hopelessly broken and can never work, or is there something in there that we need to look at that we have not yet spotted?

Alison Carnwath: I think, in a nutshell, remuneration committees will work if they are on the same wavelength as the chief executive.

Q3277 John Thurso: And the chairman?

Alison Carnwath: And the chairman.

Chair: That is extremely helpful.

Q3278 Lord McFall of Alcluith: I want to look at the structured markets division. You mentioned that Bob Diamond was very talented at building up BarCap. If we look at Barclays’ share price, in 2003 it was £5, but in 2013 it is £2.98, so the price has gone down, but according to reports, Bob Diamond is worth about £105 million, mostly from Barclays Capital; since joining the board in 2005, where there is public disclosure, he has taken £75 million. He was the driving force, along with Roger Jenkins, of the structured capital markets. We have had witnesses before our Committee saying that the sole purpose of the structured capital markets is to make money by selling tax avoidance schemes to each other. At one stage, with BarCap, a witness told us that by the mid-2000s, the structured capital markets team in Barclays contributed 110% of the profits of Barclays Capital, so essentially the investment bank operations were being subsidised by tax avoidance. Did you know that that was going on? If not, how do you feel it reflected in the culture and standards at Barclays?

Alison Carnwath: It was way before my time. I did not know those figures, and if they are correct, that is interesting. I do not feel good about that at all. First of all, I never feel good about a massive concentration of profits coming from one particular source; I always think that is a great danger sign. Secondly, it leads to perfectly perverse behaviour, as we have seen on many occasions, where a small group of people get paid a lot of money because one particular part of the bank is doing very well. That sort of thing needs to be stopped.

Q3279 Lord McFall of Alcluith: But a lot of Bob Diamond’s rewards came from that.

Alison Carnwath: Possibly. I do not want to sound completely defensive, but I just wasn’t there when that was going on.

Q3280 Lord McFall of Alcluith: Let me ask this, then-and I think you will agree with me: should banks carry out transactions that have no business purpose other than minimising tax, while dressing them up to appear as if they have a commercial purpose?

Alison Carnwath: Put like that, no.

Q3281 Chair: You were there when he was engaged in beefing up the tax avoidance side of Barclays, weren’t you?

Alison Carnwath: I was there from August 2010, so he was president and on the board. He became chief executive 15 months later. I was clearly less aware than I should have been about these activities.

Chair: Okay, that’s fine. Thank you very much for coming to give evidence. It has been brief, but extremely interesting, and we are very grateful to you. We will now take a five-minute break and then resume with the next group.

Examination of Witnesses

Witnesses: Sir John Sunderland, Chair of Barclays Board Remuneration Committee, and John Thornton, Chair of HSBC Board Remuneration Committee, examined.

Q3282 Chair: We are running slightly behind schedule, so if it is all right, we will begin. May I begin by asking you, Mr Thornton, how much you are paid to be chairman of REMCO and to be on the board? What is your total remuneration?

John Thornton: £100,000.

Q3283 Chair: The annual report shows total fees of £1.08 million for 2011. What is that for?

John Thornton: Because I am paid also for a role as non-executive chair of a north American holding company, which is a separately regulated entity.

Q3284 Chair: I see. How much are you paid to be non-executive chair of that?

John Thornton: US $1.5 million.

Q3285 Chair: And is that a full-time job?

John Thornton: It is not full-time, but it is very involved.

Q3286 Chair: Give us a feel for what "very involved" means. How many days a week do you spend looking after the north American arm?

John Thornton: The way I would answer that is that in recent years, with all that has been going on in the way of regulatory and legal issues and so on, there is not a single day when I am not working on it. I do a number of things, but if I were to try to divide it into days per week and try to aggregate it, I would say probably half the week.

Q3287 Chair: So it is a part-time job with about half the week devoted to it. You are also a director of the Ford Motor Company, News Corporation Inc. and China Unicom. Is that correct?

John Thornton: I am actually no longer a director of News Corporation, but the others are correct.

Q3288 Chair: But at the time that this annual report was published, you were.

John Thornton: Correct.

Q3289 Chair: So how many days a week do you spend on the REMCO job at HSBC?

John Thornton: A lot. The answer to that question is that several times a week, something comes up and then there are points in time where it is intense-

Q3290 Chair: I am looking at average per week.

John Thornton: I do not think about it that way, but I would say that in the course of year-

Q3291 Chair: I will divide by 50 if you give me a yearly figure. I would be grateful for a weekly figure. We have two and a half days-

John Thornton: Let’s say a day a week.

Q3292 Chair: So that’s three and a half days. You are paid £1.1 million for three and a half days a week at HSBC. Is that right? Do you think that makes it at all difficult when setting pay?

John Thornton: No.

Q3293 Chair: You find the fact that you are paid very large sums has no bearing on the way you might approach other people’s remuneration?

John Thornton: Correct.

Q3294 Chair: And you expect also that their view of any decisions you take will not be influenced by your pay?

John Thornton: I am sorry. Decisions that they-

Q3295 Chair: If someone is setting your pay and they are paid a great deal of money, it might influence the way you view the decision that person takes. What do you say?

John Thornton: I am not sure I understand the question. You are saying that people whose pay I am deciding-

Q3296 Chair: You are setting the remuneration of others. Those people know how much you are paid, don’t they?

John Thornton: Yes.

Q3297 Chair: Do you think that influences the way they view your decisions?

John Thornton: Generally not that I can see.

Q3298 Chair: You do not think so?

John Thornton: I think generally not, but I can see how it might.

Q3299 Chair: Sir John, I am told by the newspapers that you are thinking of giving Antony Jenkins a bonus. Do you think that is appropriate, bearing in mind that the shareholders who will be taking the hit are at the moment in the frame for effectively having to pay out for the huge PPI fines?

Sir John Sunderland: What you read in a newspaper is obviously speculation. I have spent a lot of time over the past few months talking to shareholders personally so that I understand their perspective on remuneration. I regret to say that some of those conversations have inaccurately been leaked to the media. I can tell you that Mr Jenkins’s bonus has not yet been determined or finalised. What you read is speculation. I do not think I can add anything further at this stage.

Q3300 Lord Turnbull: Sir John, before you became chairman of REMCO, were you a member of it?

Sir John Sunderland: I was.

Q3301 Lord Turnbull: Alison Carnwath says she was on her own. In other words, you did not support the view that she was taking?

Sir John Sunderland: I did not.

Q3302 Lord Turnbull: Don’t you think, in view of what subsequently happened-it didn’t produce a 50% vote against, but a pretty large number of shareholders were against; it got a very large thumbs down from public opinion; and, in the end, the Bank and the regulator were part of the objection to the continuation of Bob Diamond-you were on the wrong side of the argument and made a major misjudgment?

Sir John Sunderland: I do not feel that. I think the debate that took place at the remuneration committee, and subsequently at the board, is a reflection of exactly what should happen. There is a vigorous exchange of views and different ideas, and you hope to reach a consensus. When you get a tremendous polarity of views, which we had in this case, and which was accurately reflected by Alison Carnwath, the issue is thrashed out in discussion and a consensus is reached. The board reached a unanimous decision about pay. I assure you that all the shareholders we talked to did not feel that Mr Diamond should not receive any bonus compensation; the thing that upset them, more than anything else because it came as a surprise, was the tax equalisation element, which attracted a lot of publicity at the time. We did not hear anyone suggest to us at the time that he should receive no incentive compensation at all. With the benefit of hindsight, would it have been better if it had been less? Possibly. By what quantum? It is difficult to say.

Q3303 Lord Turnbull: Surely more than possibly. In the subsequent argument, the recommendation of the board was thoroughly disapproved of by a very wide range of people. In the end-you say it went through as it should be-it is surely not good practice to propose a bonus and have to back down subsequently. That must involve some substantial degree of misjudgment.

Sir John Sunderland: Well, of the shareholders who voted, 73% voted for the remuneration report; 27% did not, some of whom were major shareholders. Indeed, some of those who voted for it were major shareholders. We took pains to talk to those who were clearly disaffected by the decision-the minority-and a further conditionality was imposed upon the bonus that had been awarded to Mr Diamond. If three quarters agree and a quarter do not, I do not think that that necessarily implies a complete misjudgment.

Q3304 Lord Turnbull: How many people voted for it but were quietly telling you, "I’m not going to vote against it and cause you a problem, but I want you to sort this out-I don’t really like it"?

Sir John Sunderland: I think those people were more likely to abstain, and I think that there were some abstentions from the voting. When you get a 27% vote against your remuneration report, you take it very seriously, as we have done. But it is a retrospective action. The implications of that have resulted this year in far closer consultation between myself and our shareholders, and, I hope, a different set of decisions that I hope they will support.

Q3305 Lord Turnbull: But this chorus of disapproval wasn’t simply the shareholders; in the end it was such that the board had to back down and change the decision. In the end, the chairman and the chief executive left.

Sir John Sunderland: For completely unrelated reasons, yes.

Q3306 Lord Turnbull: Come on! Not completely unrelated reasons. What then produced the letter from the Bank of England saying, "We’re not happy with the way that this bank is being run-the culture has been insane"? The pay was all part of the same thing, which is the culture that you supported. You did not support someone who was putting another argument, on which, I would say, subsequent history showed that she was exactly right and you were exactly wrong.

Sir John Sunderland: Well, Lord Turnbull, that is your opinion. It is not mine.

Q3307 Lord Turnbull: But don’t you think it damages your credibility as the chairman of the REMCO to have been so much on the wrong side of the argument?

Sir John Sunderland: I think I would prefer to be judged as chairman of the remuneration committee on the decisions that we make this year under my chairmanship, not on a decision that was unanimously supported by the entire board, on which a dissenting view was expressed by one member.

Q3308 Lord Turnbull: I would have thought that the chairman of the REMCO is not simply just one member.

Sir John Sunderland: But that chairman, in the end, was part of the unanimous decision.

Q3309 Lord Turnbull: The other criticism that was made of the decision is that, at the time that you made it, there were a number of things that you must have known were brewing. You must have known about mis-selling and the fines. You must have known that the LIBOR investigation was going on. With all those things, in a world of clawback, you could pay a bonus, but, knowing what we now know about mis-selling, such bonuses would be eligible to be clawed back. Yet still you persisted with this high bonus, knowing that there were these shadows on the horizon. I would have thought that you would take a lot more care not to get yourself into the position of paying right at the high end of acceptability when people later in the year would come to say, "Had I known that, I would’ve been even more cross about the bonus that was proposed."

Sir John Sunderland: You mentioned two issues, one of which was LIBOR. Other than knowing that there was an inquiry going on, the board had no insight at all as to the documentation that went to the regulators and the final decision that was made.

Q3310 Lord Turnbull: You must have known that you were in a certain amount of trouble on it.

Sir John Sunderland: We knew that there was an investigation, but I tell you frankly that we had no idea of the content of the subsequent e-mail trail and all the issues that came to attract the degree of opprobrium that that situation did.

I do not know whether people have said this to you before, but just to be clear on PPI, it is something that has been sold for over 20 years. The great majority of all the PPI sales were made in the 10 years prior to the current period. Most of the people associated with that have long gone from the bank, and those who remain have been more concerned with the remediation of the issue in the recent past than they have with carrying the responsibility for what happened. It is important to appreciate that this is an issue that goes back 20 years. It is not what we have been talking about over the past four or five.

Q3311 Lord Turnbull: No, this is just rubbish. This Committee has done a lot of work on it.

Sir John Sunderland: Could you tell me why my statement is rubbish, Lord Turnbull?

Q3312 Lord Turnbull: Because-this is not going back 20 years-the complaints started to reach a crescendo in 2005 with the super-complaint from the CAB. In 2005, the FSA has its first thematic review. It has another thematic review in 2006 and another in 2007. On and on the saga goes, and it gets referred to the OFT. Meanwhile, Barclays, among others, is choosing to fight the FSA on a principle in law over whether things are governed by principles or rules. All the time, they knew that there was a great deal of information that this product, which started life as a perfectly legitimate product-by 2005, people began to see that this product was being sold to a lot of people to whom it should never have been sold. Despite that, Barclays and other banks went on defending this to the death, even to a judicial review. The idea that this is something in the past-some legacy issue-I completely reject.

Sir John Sunderland: I do understand the point that you are making. My facts are correct, but I do understand what you are saying.

Q3313 Lord Turnbull: So are mine.

Sir John Sunderland: Indeed, but we are talking about two different things.

Q3314 Lord Turnbull: They are incompatible, aren’t they?

Sir John Sunderland: No, they are not. I said to you that the great majority of PPI policies, which started 20 years ago, were sold over 10 years ago. That is an accurate statement. The point that Lord Turnbull is making is that during the period from 2005 when sales incentives were attached to the selling of those products and complaints grew, the industry chose, as you rightly said, to take the point to a judicial review. That is an accurate statement as well, but they are just two different facts. I am not trying to defend it; I am just trying to explain the situation.

Q3315 Lord Turnbull: A separate panel of this Committee has been looking at it, and you can see from the nods around the table that my account of it corresponds more with their thinking than does your account.

Can I just come back to one other thing? There is a reference in Alison Carnwath’s paper to the return on equity of Barclays being below the cost of capital. Is it not the case that, leaving aside the incentive structure, the sheer volume of pay is incompatible in a world in which £1 billion of capital will support maybe half the level of lending that it used to support? The business model just does not work any more, which means that there have to be massive reductions in the volume of pay, particularly in the investment and trading part. Are you grasping that urgently?

Sir John Sunderland: It is a very good point. Are we grasping it urgently? You heard Alison Carnwath say that last year’s incentive compensation-60% of our total compensation bill is fixed. On the incentive side, we reduced the incentive compensation in the investment bank by 30% last year and in the total bank by 26%. That was against a performance that was flat. This year, we are in a closed period but the consensus will tell you that our financial performance is expected to be materially ahead of the previous year, and it is our intention that incentive compensation will continue on a downward trajectory. The issue of cost of equity-return of equity-being high at the moment is manifestly correct. It is driven, as I am sure you know, largely by the increased regulatory requirements. Even if we took out the whole of the incentive compensation, it would not put us into a positive return of equity territory. What we have to do is try to find a balance between the protection of the franchise, reducing compensation and increasing returns to shareholders over time, thereby hopefully reflecting an increase in return equity as well.

Q3316 Lord Turnbull: Just one final point. What you call an increase in regulatory requirements is what I would call retaining adequate capital to run the business.

Sir John Sunderland: The views on that subject have changed. You are correct, but it wasn’t the view when you go back six years, as I am sure you also know.

Q3317 Chair: But this increase in regulatory requirements is in fact employing teams of experts, including lawyers, in order to work out how much you should be compensating on PPI, isn’t it?

Sir John Sunderland: No, I am talking about the regulatory requirements for increased capital in the banking industry.

Q3318 Chair: Ah, in that case, all you’re really saying is that we are getting back to a cost base that is more balanced; one which reflects more accurately the risks that you are taking on behalf of your shareholders.

Sir John Sunderland: It is an entirely different regime now from what it was five years ago. I of course accept that.

Q3319 Chair: Why not replace the word "different" with another adjective? It’s not just different, is it? They are not equal one way or another. One of them is an extremely dangerous model and the other is a safer one.

Sir John Sunderland: Manifestly so, but I am here to talk about remuneration. On that issue, the regulators, the bank, nobody was expressing the point of view that you have put succinctly now to the industry at that time.

Q3320 Chair: Can I take you back to this decision in 2011, which you took part in, to award Bob Diamond a bonus? You do agree that that decision was a profound mistake, don’t you?

Sir John Sunderland: No, I don’t. I think you could argue about the quantum of the bonus, but I don’t regard it as a profound mistake. I do not.

Q3321 Chair: So you think that, when a business is not covering the cost of capital and the share price begins to show poor returns, that is the sort of environment in which it is still fine to pay out a large bonus?

Sir John Sunderland: If I can explain why everyone except Ms Carnwath supported the decision to award a bonus to Mr Diamond-

Q3322 Chair: The others may all have been wrong as well. We would just like your reasoning.

Sir John Sunderland: If I can explain the reasons behind it. I sat on the remuneration committee at that time, I supported the view I have expressed and I said the same thing at the board meeting. Mr Diamond had been appointed to the position of chief executive. He had engaged in that task with great energy, enthusiasm and skill. He is an extremely successful banker. You may argue about culture and values and I am perfectly prepared to do that, but he had a series of objectives which had been set for him in the year and many of those were achieved and attained. Obviously, the bank was not returning a positive return equity versus its cost, but there were exogenous factors influencing that, which we have just discussed. The board took the view that Mr Diamond’s performance overall, the enthusiasm, skills and ability that he brought to bear, deserved some recognition. That was not the view expressed by Ms Carnwath and, in retrospect, you could say that she made a different decision which has justification, but we felt that at the time and I felt that at the time as well.

Q3323 Chair: And you still feel that now?

Sir John Sunderland: I do. I could argue about the quantum-

Q3324 Chair: So if you were faced with that decision again, you would still have paid Bob Diamond a bonus?

Sir John Sunderland: I would have debated the quantum, I think. I accept that, but I would not have recommended a nil bonus for Mr Diamond.

Q3325 Chair: When the public hear phrases like "deserved some recognition", let us suppose that he had been paid zero from his bonus, what would have been his recognition? What would have been his remuneration? How much would he have been rewarded?

Sir John Sunderland: His salary?

Q3326 Chair: Well, he has got a salary and other forms of remuneration. I have not got the full package in front of me but it had a good number of components. I cannot remember them all, but it is not just salary. Suppose we take the bonus out of this, what is left?

Sir John Sunderland: The salary I think was £1.35 million, if I recall correctly, which would have been paid to him. Whether there would have been the argument that he would not have been given a bonus-

Q3327 Chair: So that is before we take account of LTIPs or any other remuneration?

Sir John Sunderland: That is at the discretion of the committee as well. Whether we would have given him an LTIP if we had not awarded him a bonus-possibly, possibly not.

Q3328 Chair: It is just this phrase "deserved some recognition". You know, £1.3 million, by any stretch of the imagination, is what most people would consider to be a bit of recognition.

Sir John Sunderland: I agree, but it is also important that we measure this by the standards of the industry within which we operate.

Q3329 Chair: In 2011?

Sir John Sunderland: In 2011. I am sure you are aware of all the other compensation that was paid to other chief executives, both here and elsewhere, which is the market we compete in.

Q3330 Chair: You see, Sir John, what we are looking at is standards and culture in banking. What we are really concerned to find out is whether they really have changed or whether they are much the same.

Sir John Sunderland: I have a very strong view on that if you would like to hear it.

Q3331 Chair: Some of the information that you are telling us this afternoon suggests that they have not changed very much. You are saying that even though the guy is already going to get £1.3 million, he deserves a bit more recognition on top in a climate in which-I can only repeat-on the key measure of ROE, the bank was not covering the cost of capital, and the share price and the dividends were showing poor returns. Most people would consider that absolutely extraordinary, Sir John.

Sir John Sunderland: If we are talking about value and cultures and what is changing in the bank, I think you have already referred to Mr Jenkins’s expression of how he wants Barclays to change. I can assure you that the entire board obviously is behind that and we would expect that to be reflected not just in the way the bank does business, but the way in which people are compensated. That is a process which we are engaged in at the moment. I think there is a substantial degree of change going on in the bank at the moment.

Q3332 Chair: I do not doubt that, but what we have had is, frankly, a lack of repentance about what most people would consider to be an appalling decision in 2011. You are unrepentant, aren’t you? You have said, "Well, he ought to have a bonus."

Sir John Sunderland: I think Bob Diamond deserved a form of incentive compensation. I am prepared to debate the issue of context. I think there are other elements of his performance that we had to assess.

Chair: That is fair enough as a view, even if I do not agree with it.

Q3333 Lord McFall of Alcluith: You heard Alison Carnwath talking about structured capital markets and we have had witnesses saying that the sole purpose of these is to make money by selling tax avoidance schemes to each other. Did you know what the structured capital market division was doing?

Sir John Sunderland: The statement you have just read out would be a complete surprise to me. I am not sure that I accept it.

Q3334 Lord McFall of Alcluith: Do you accept that one well-informed witness told us that in mid-2000 the structured capital market team in Barclays contributed 110% of profits to Barclays Capital. Do you accept that?

Sir John Sunderland: No, I do not.

Q3335 Lord McFall of Alcluith: Okay. It is a big thing here, Sir John. It will take more than a few e-mails for Barclays to change its image. A big effort has gone into saying that everything has changed. I issue you a challenge here: let us send someone in to look at the structured capital market, to look at how Bob Diamond got his £105 million over the next 10 years and then we will believe that there was a step change to good culture and a step change to transparency. Do you accept that challenge?

Sir John Sunderland: I think Mr Jenkins expressed in his statement about values and culture how the bank is going to change. I think that would certainly include a review and substantial change to the things you are referring to.

Q3336 Lord McFall of Alcluith: I am asking you to accept the challenge that Barclays opens up the books so that we know how the bank that Bob built was built. I am asking you to take that back as the chairman of REMCO.

Sir John Sunderland: Lord McFall, I will convey your view. It is not within my power to make such a commitment.

Q3337 Lord McFall of Alcluith: Will you discuss that with your board and then come back to this Commission?

Sir John Sunderland: I will certainly reflect exactly the question that you have posed.

Lord McFall of Alcluith: Otherwise it just seems as if it is a PR exercise.

Sir John Sunderland: What is a PR exercise?

Lord McFall of Alcluith: Barclays change of culture, if we do not understand exactly how this bank was built.

Sir John Sunderland: I would like that to be judged in the future rather than right now, but I will certainly pass on your message.

Q3338 Lord McFall of Alcluith: I will ask you a final question then. Do you think that banks should carry out transactions that have no business purpose other than to minimise tax, and then dress them up to appear as if they had a commercial purpose?

Sir John Sunderland: I cannot defend that, no.

Q3339 Lord Lawson of Blaby: Following on from that, if I may Sir John: were you aware that the biggest single component of Barclays Capital’s profits was the tax avoidance business? I think you said that a moment ago, but I would like to make sure. Were you aware of that?

Sir John Sunderland: I am not sure that I accept it.

Q3340 Lord Lawson of Blaby: Well, you do not accept it because you do not know. We have had witnesses who do know, who were working there. They are inside witnesses who have assured us of this. So you did not know what was going on.

Sir John Sunderland: If you are telling me that of the entire investment bank the structured capital markets business in a period of time-I am not quite sure which one it is referring to, whether it is a year, two years or 10 years; I don’t know-was 110% of the business-

Q3341 Lord Lawson of Blaby: In one particular year, that was the peak, but it was a substantial amount year on year. It has largely finished now, I agree-for the time being-but during the time we were talking about-

Sir John Sunderland: Well, I don’t know which year we are referring to.

Lord Lawson of Blaby: 2000.

Lord McFall of Alcluith: It is mid-2000, but it is the principle. It is the point that Lord Lawson is making.

Q3342 Lord Lawson of Blaby: I am concerned about whether you were aware-you clearly were not-and whether you feel that you should have been aware.

Sir John Sunderland: Can I respond please? We saw the profitability by division of all the elements in the investment bank, including the structured capital markets division, and at no time can I report that that constituted 110% of the total profits of that bank.

Q3343 Lord Lawson of Blaby: What did it constitute?

Sir John Sunderland: I do not know. In front of you now, I have no idea, but I will certainly check it out.

Q3344 Lord Lawson of Blaby: And can you let us know?

Sir John Sunderland: Yes.

Q3345 Lord McFall of Alcluith: Finally, when did Barclays stop selling PPI?

Sir John Sunderland: In 2009.

Q3346 Lord McFall of Alcluith: A number of people from Barclays have spoken to me over the years, and one who was very much involved in Barclays said that the executive team in Barclays were trying to persuade the board, and maybe a committee of the board, to continue selling PPI in 2008.

Sir John Sunderland: Persuading which committee of the board, or the board?

Lord McFall of Alcluith: The executive team were asking the board.

Sir John Sunderland: Certainly I can recall no conversations in which we were being persuaded to continue. I do not recall that.

Q3347 Lord McFall of Alcluith: So why did it take you to 2009 to stop selling PPI, when we had a cascade of press reports and referrals to the OFT/ Competition Commission? Wasn’t it just the case that it was a good money spinner, and you were going to spin it out for as long as you could?

Sir John Sunderland: No, that is not my recollection at all. To the extent that PPI was discussed, it was felt that a series of remedial actions was being taken by the management at the time, once the issue had become more public, and that they were addressing them. That was the information that was provided to the board, and I have no reason to disbelieve it.

Q3348 Lord McFall of Alcluith: I was a customer of Barclays until 2005. I left because I went into the Victoria branch after I was elected and asked for a loan of something like £12,000, and they asked if I wanted PPI. I said, "No, I ain’t going to be unemployed in the next five years." Barclays sent me eight letters thereafter. It was nothing other than bullying. I knew what I was doing, and I didn’t accept it . I told your board-your chief executive and your chairman-exactly what had happened. In November 2005, I told Callum McCarthy and John Tiner to do something about it, and nothing was done about it by your board or others because you were making a good whack of money out of it.

Sir John Sunderland: Is that a question, Sir?

Lord McFall of Alcluith: I am telling you my experience as a customer of Barclays, and that is why I left Barclays. So you can take that back to your board.

Sir John Sunderland: I will convey it.

Q3349 Mr Love: Can I turn to an issue that Lord Turnbull touched upon, which is clawback arrangements? This is a requirement from the FSA, but can both of you confirm that you have clawback arrangements at your banks?

Sir John Sunderland: Absolutely.

Q3350 Mr Love: And are those clawback arrangements as the public would understand them: you can claw back both paid and deferred remuneration or is it just deferred remuneration?

Sir John Sunderland: It is both, and we are in the process of considering for this year and for last year exactly the degree of malus, which is the phrase that is used in relation to clawback. That is both on clawback that we feel is appropriate for any incentive compensation that might have been paid in relation to 2012 and also, in a number of cases, we are clawing back––applying malus––to a number of outstanding awards, particularly individuals to whom that has been paid, but because it is deferred we have the opportunity, through the remuneration committee, to pull back anything up to 100% of it, which in some cases we have done.

Q3351 Mr Love: Can Mr Thornton just confirm that that is the case? As I understand malus, it does not include remuneration that has already been paid. You are suggesting that you can claw back the remuneration that has been paid?

Sir John Sunderland: That has been deferred.

Q3352 Mr Love: It is only deferred. What is the time scale for that? Medium term, long term?

Sir John Sunderland: If I can just give you an illustration, 75% of the investment bank bonus paid last year to all of the investment bank was deferred for three years, and we have the option to claw back up to 100% of that if required.

Q3353 Mr Love: Is it a three-year, five-year, 10-year deferral period, and can you claw back all of it?

John Thornton: We can claw back all of the short-term bonuses, or three-year vestings or three years deferred; and the long term is five years.

Q3354 Mr Love: Mr Thornton, HSBC’s fine regarding anti-money laundering measures was $1.9 billion. Will that money be considered for a clawback and incorporated in your management’s compensation this year?

John Thornton: Yes, it is reflected in a number of different ways. First of all, of course, it comes out of the profits of the bank. Therefore, it affects the profit pool to begin with. Secondly, depending on the circumstances, there are individuals who have simply lost their job, and then there are other individuals for whom we are assessing clawback in respect of their particular role in the problems that were created.

Q3355 Mr Love: And can you just be clear with us that you fully intend that, if those individuals are found to have had a role in this activity, there will be either disciplinary action or clawback arrangements?

John Thornton: Yes.

Q3356 Mr Love: Sir John, LIBOR manipulation, which Lord Turnbull mentioned, of course it could have been done at the time but now you have the opportunity to claw back where an individual has been involved in these manipulations. Is that something that Barclays is considering at the present time?

Sir John Sunderland: It has not only considered it; it has been done already. I sat on a sub-committee of the board, which oversaw the disciplinary process in relation to LIBOR, and all those employees who remain with the bank-many have left-have been subject to a disciplinary process and they have either been dismissed-in some cases, they have been dismissed-or given formal warnings if they were at the margin of the activity. In the cases of those who have been dismissed, 100% of their deferred remuneration was clawed back.

Q3357 Mr Love: I understand that, but there is a wider group that will not have been directly implicated but that should have been aware. Are there arrangements for what to do in those circumstances?

Sir John Sunderland: We have applied a malus provision to compensation in relation to the wider universe of people in the investment bank as well.

Q3358 Mr Love: Can I just be clear that, in principle, you would accept that there should be a clear link and correlation between the bonus pool and the level of penalties and fines that are levied?

Sir John Sunderland: Absolutely.

Q3359 Mr Love: Can I come on to something else, and that is the balance between fixed and variable remuneration? I think that you both said earlier that the level of variable remuneration has gone down in recent years for obvious reasons-because of the performance of both of your banks. But there is increasing evidence being given to this Commission that the level of fixed pay has gone up, compensating senior executives for the loss of variable remuneration. Do you recognise that, and you recognise the complaint that banks seem to be looking after their senior representatives in this way?

Sir John Sunderland: There was pressure during the financial crisis-rightly-on us as a bank for the fixed element of pay to be increased and the variable element to be reduced. To some extent, there was a degree of increased fixed remuneration, but it was not the clawback-the pulling down of variable compensation was far greater than any increase in fixed amounts.

Q3360 Mr Love: Would you concur with that, Mr Thornton?

John Thornton: No, I would say that fixed compensation was not raised for the reasons you are indicating. And our variable-we had an extensive series of conversations with shareholders two and a half years ago, out of which came a new system, particularly for the most senior people. That new system essentially answers the following question: if you have 10 units of remuneration and you were dividing them between salary, short-term bonus and long-term bonus, how would you wish those 10 to be divided, assuming that the bank was profitable and that the individual was doing well? The answer from that extensive consultation was one unit in salary, three units maximum in short term and six units maximum in long term; if you achieved the maximum units in the long term, you would be paid only in shares, and you could not sell those shares until you retired. Given everything I have just described, the direct answer to your question is that fixed has not gone up as a result of pressures from anywhere.

Q3361 Mr Love: We are aware that HSBC has a longer-term incentive scheme than most other banks.

Let me press you, Sir John, in relation to Barclays. If you make a comparison between 2010 and 2011, whereas return on equity went down and, as a result, the variable payment to senior executives went down, yet overall compensation-that is taking in fixed and variable-remained pretty similar, at £11.9 billion in 2011 and £11.5 billion in 2010. That indicates very clearly that fixed remuneration increased to compensate for the fall in variable remuneration. How do you respond to that?

Sir John Sunderland: I think that that may also reflect the extent to which we were expanding the activities of the bank-the number of employees increased.

Q3362 Mr Love: Perhaps you could give us a note in relation to the years since 2010. Would that be okay, Chair, if we could have a note explaining the apparent maintenance of overall compensation?

Chair: Yes.

Sir John Sunderland: We will certainly follow up on that

Q3363 Mr Love: There is a discussion going on, particularly at European level, around capping variable remuneration as a percentage of fixed remuneration. Do either of you have any sympathy for that idea?

Sir John Sunderland: No, I think there is an inherent danger. Another way of describing a bonus is, obviously, variable pay. The benefit of variable pay is that you have the option, clearly, to react to any circumstances in which the bank could find itself in extremis by reducing variable pay to zero. That is what lies beneath that concept. To turn that on its head and to have the fixed element of bankers’ compensation as such a high proportion seems to me to be completely against the logic of the situation that currently supports the idea of variable pay being a helpful element for us. I am not terribly empathetic to that idea.

Q3364 Chair: I do not find that argument terribly convincing. After all, why cannot one write contracts that enable you on an annual basis to vary the core salary, downwards as well as up? Other industries do that all the time. Small business men find their salaries halved or doubled according to their performance.

Sir John Sunderland: For the size of business we are talking about, it would be a dramatic shift, and a very new concept. I accept the logic of the point you are making, but-

Q3365 Chair: It is not a new concept in most of the private sector.

Sir John Sunderland: If variable pay is 3 or 4:1 to fixed pay, you have significant levers. If you are talking about reducing a person’s salary by two thirds, that seems to me to be possible but difficult to effect.

Q3366 Chair: Doesn’t it depend what you are earning to start with? If you are earning £1.3 million, dropping by two thirds is not going to leave you in penury.

Sir John Sunderland: It is an interesting concept; I accept that.

Chair: We are quite interested in interesting concepts on this Committee.

Q3367Mr McFadden: Can I return to the question of Mr Jenkins’s possible bonus? You are the chair of the remuneration committee. We have heard reference from you today to claims of culture change by the bank, and we have read them in the press. As the chairman of the remuneration committee, do you understand how claims of culture change will be viewed if a bonus of that order is paid?

Sir John Sunderland: I understand the implications of your question very well.

Q3368Mr McFadden: Can you expand on your answer a little bit? Do you understand what it will do to claims of culture change-both for front-line Barclays staff who work in branches on modest salaries and for the public looking at claims that the bank has changed its culture-if it pays a bonus anywhere near what is being speculated about?

Sir John Sunderland: I understand the implications of your fuller question very well. I absolutely do.

Chair: Thank you very much for giving evidence this afternoon. It might have felt a bit bumpy, but that is because this issue certainly is. I expect that there will be more exchanges between us and your respective institutions before we complete our work. We will go straight on to the next session, if we may.

Examination of Witness

Paul Sharma, Director, Policy Division, FSA, examined.

Q3369Chair: How do you feel about what you have heard so far, Mr Sharma?

Paul Sharma: It is very interesting. Perhaps you saw I was there throughout the sitting.

Chair: That is why I asked you the question.

Paul Sharma: I do not know where to start. You started at the very beginning of the session by asking why pay in the banking sector was so high. I have spent most of the time since then reflecting on the answers that were given and on my own thoughts on the subject, so perhaps I can start with some thoughts on that.

I think there are three or four principal reasons. First, there are some issues with executive pay in general, so one can reflect on the question why banking pay is so high even relative to executive pay across the corporate sector. I think there are three reasons. First, there are some issues with the profits of the banking sector prior to the credit crunch. There are some issues with the reality of those profits: to what extent were they illusory? That plays into some important work that Lord Lawson is doing on the accounting side, and I think Lord Turnbull mentioned it in passing in one of the evidence sessions as well.

Secondly, in my view, the too big to fail question is undoubtedly relevant here. To a significant extent, profits in the pre-credit crunch phase were farming the economic rent from the implicit state subsidy. That also goes to the conundrum of why shareholder scrutiny and the normal mechanisms of capitalism were perhaps not as effective as one would have hoped they would be. Where a firm is in a situation that it can farm an economic rent for one reason or another, there is not the same pressure on return to the equity holders because their needs can be more than satisfied as well as paying excessive pay.

Thirdly, there was the issue of other forms of activity that were not helpful to society. Lord McFall mentioned one in terms of the structure of tax. I suspect that is not a complete list by any means. So that would be the first set.

If you make that much inappropriate profit, that creates a powerful incentive, no matter how good the other controls are, in order to pass that through to the people who are perceived to be among those who obtained that profit. In fact, it is probably more to do with the system than with the people.

Secondly, I had a lot of sympathy with some of the comments made in the first session about issues to do with the narrowness of the talent pool. I do not go as far as saying that the people running the banks and our major financial institutions are talentless, by no means whatsoever would I say that. But, there are very talented people who are not being drawn into the talent pool to run our major financial institutions and to serve at all levels.

Q3370 Chair: You are not going to suggest that we need higher pay in order to get these people, are you?

Paul Sharma: No, quite the opposite. I suspect the culture created by a number of things, including the high pay culture, is one of the things that puts people off.

Q3371 Chair: This is a new-this is the backward-bending demand curve. The more you pay, the fewer you have of them. Anyway, let’s hear the explanation.

Paul Sharma: Let me explain my point. Pay is undoubtedly a powerful incentive, but culture is also a powerful incentive that attracts people and puts people off working in environments. Whatever the precise reason, there undoubtedly is an issue with the narrowness of the talent pool. There was something in what was said in the first session that very much chimes with me. If you take some very simple ways of looking at the question, for example, if you look at senior management just from a simple diversity point of view: male or female, ethnic groups, and so on. You can look at it in more complicated ways than that.

Q3372 Chair: I am sorry, it is just that we are pressed for time. You are saying that it is the poor culture that is putting good people off.

Paul Sharma: Indeed.

Q3373 Chair: So, if we do a good job on the Banking Standards Commission and improve the culture of banking, we will have to pay them even more?

Paul Sharma: No, on the contrary. It is the other way around.

Q3374 Chair: They will be so anxious to come in that we can then drop the pay?

Paul Sharma: If you buy the argument of some of your first panellists that the limited nature of the supply of very talented people was partly an issue, then I think you understand how the logic flows.

The third main area was the poor structure of remuneration and the whole question of the amount that was deferred and the misalignment of incentives at a technical level. I would say those three reasons, broadly speaking.

Q3375 Chair: You have been very frank and very interesting so far. Can I just ask one very straightforward question. Obviously it is a question in which you have a vested interest in a particular reply, but I hope I will get something that looks beyond that. Do you really think in your heart of hearts that a regulator can make much difference in this area?

Paul Sharma: I have a fairly plain reply to that. The issues that you have been talking about are societal choices. The role that the regulator can play is in executing the societal choices provided they are made sufficiently clearly and with the necessary consequential powers, and so on, made by Parliament.

Chair: That is passing the buck slightly, but I am going to pass the buck to John Thurso.

Q3376 John Thurso: Can I ask a quick follow-up question on your very interesting response to the Chair in relation to culture, and the fact that the wrong people are coming in? You suspect that high pay culture may be a barrier. Are you aware of the personality testing that all banks do in order to select the people best suited to be their leads in these areas? Are you aware that the trait they look for is what is known as the warrior quality? Are you aware that on the personality curves-the data that show, for example, where women are, where men are, and who is in between-these people are exclusively in the 5% to 10% at the testosterone end? If you are aware of all that, is it part of the explanation?

Paul Sharma: Indeed. Your characterisation of my remarks was, the wrong people have been brought in. My characterisation would be, not enough of the right people are being drawn in. The short answer to your question is yes. In part, that is what I was alluding to. Basically, if we want a safer banking system, and if we want to change culture, we need a much wider range of personality types and backgrounds. We need diversity. If we want that, however, the culture itself has to change. The two feed into each other. At the moment, it is a vicious circle, but it could be a virtuous circle.

Q3377 John Thurso: The point I put to you, because you are the regulator, is we all want to change the culture, but culture is usually regarded as a subjective thing that a jolly good chap, the leader, makes happen by doing lots of jolly good things that get taught at business school. What I am putting to you is that it is not nearly that accidental. It is a direct result of going out to put warriors on the front line, who have the same characteristics as the guys who pass into the SAS, but with maths and finance added. Therefore, as a regulator, do you not have a role to look at the HR procedures and the HR scores? If we are looking at regulation as part of the armoury for change culture, then those are areas that you-even if it is informally and not part of a formal assessment-should be looking at in your health checks on banks and other institutions.

Paul Sharma: Yes, yes, yes and yes. In terms of our preparation for the PRA, I have initiated-and we have held the first meeting-a meeting in which we get together the heads of HR of all of the major UK banks and insurers in order to start a collective dialogue about a set of issues that include the issues you just described. The recruitment appraisal, decisions on pay increases, promotions and ways of getting money to people by way of reward other than the bonus system are all important communicators of what really matters in a culture. As we tighten up on the bonus system at a technical level, those other methods will be used more unless the culture changes.

Q3378 John Thurso: So when the Treasury Committee has the top people from the various regulators in front of them, as they will do on a regular basis, this sort of question-"How are you doing on this?"-should be front and centre in our questioning if we are genuinely concerned about culture change.

Paul Sharma: Yes. There is nothing wrong with the type of people you just described, but that narrowness leads to monoculture.

Q3379 John Thurso: No, but it’s the complexity of all the people together.

Paul Sharma: Yes. Monoculture leads to group-think, which leads to a number of different threats to financial strength, and is therefore an unavoidable issue for a prudential regulator.

John Thurso: Let me come to a second area. As you know, we are a little short of time. Thank you for staying so long.

Chair: And for such clear answers: yes, yes, yes, yes.

Q3380 John Thurso: That will go down in the annals of history as the best answer we have had. Turning to remuneration committees, you heard the evidence Ms Carnwath gave regarding the difficulty with her colleagues. You heard her evidence that in all other respects it was a model of good corporate governance. You heard the evidence of other people on that. In the first session we had evidence about recruitment consultants being useful, less useful or whatever.

What dialogue should the regulator have with REMCOs and REMCO chairs to ensure that the chair and the REMCO have the spine-stiffening necessary for them to do the job we want, rather than that the chief executive and chairman might want?

Paul Sharma: Clearly, we have, and increasingly need to have, a strong dialogue with the chairmen of REMCOs, so that they feel capable of standing up for the major issues that they identify in remuneration. But, I think that one of the witnesses said, basically speaking, that the REMCO works very well when it is aligned with the chairman and the chief executive. Really it gets quite difficult when it is not.

My own reflection is that we are, and should, and will be increasingly focusing on making REMCOs work better, but they can only take you so far. The basic culture issue is not addressed. The REMCO in and of itself can’t solve the problem. Getting the REMCOs right is an absolutely necessary part of the solution but it is only 5% or 10% of the solution.

Q3381 John Thurso: Thank you. The critical point there, of course, is that the culture, if you like, of the executive board and probably chairman in most institutions has the incentive towards placating the executives, ensuring they stay and go on making lots of money for shareholders. The incentives are very much on the shareholders-quite a narrow band of the balance sheet-and the management who are supposed to be delivering on them. If you then have a strong regulatory input at REMCO, the incentive changes to become one where they have another set of stakeholders to take into account, in the very particular circumstances of financial institutions. You accept that responsibility and you believe that it is an incentive. It may do only 10% of the job but it is an important part.

Paul Sharma: It’s an important 10%.

Q3382 John Thurso: One last question, if I may, is to ask for your observations regarding the changes in remuneration that have taken place over the past three or four years. When we in this place all said that massive bonuses were unacceptable-indeed, Europe passed regulations on it-what happened, and we had the evidence in the first session, was that the variable pay duly came down, as did the total remuneration, but the fixed amount went up.

Some say that is a bad thing because what we wanted was for the bonuses to go right down and the fixed pay to go down. Some people are saying that having a more sensible "this is what I value them at" and less variable, will alter the incentives for them to work more in line with the new culture than the old. That was a very long question, but could you broadly address your views on the balance between variable and fixed?

Paul Sharma: Indeed. You very well summarised the arguments in both directions. Both sets of arguments are valid. I tend to place more weight at present on the first set of arguments, that the increase in the fixed amount is on the whole problematic. I do so for two reasons. First, there are still very significant uncertainties in the financial system, and making more of the cost base of our financial institutions unresponsive is not helpful. Secondly, I think there is a difference in the answer to your question between the eventually steady state in the perfect world, whenever we get there, and moving from where we are to where we need to get. I think it was Lord Turnbull who made this point, which was absolutely spot-on: given the very significant changes in capital requirements, the amount of lending or other banking activity you can now do with £1 billion of capital is quite different than it was pre the credit crunch. That needs to feed through into the remuneration system.

Q3383 Lord Turnbull: Including the baseline?

Paul Sharma: Yes. To some extent, making the pay more rigid at an early stage of that transition makes the transition more difficult.

Q3384 Baroness Kramer: Apropos your first remark, I can certainly say that a lot of very talented people left the industry in part because they were the folk who recognised risk and understood it, and were not willing to go along with a process and culture that was ignoring risk. I think the argument that we are missing a lot of talent is a very valid one.

Paul Sharma: Some of them-I am sorry to interrupt-were called kooks, or their sanity was questioned.

Q3385 Baroness Kramer: They did not have the testosterone to survive in the new world, which they did not recognise. I remember a lot of the descriptions. I just wanted to come back on the very narrow issue of the way in which pay can influence culture, and make sure that we are not over-egging the role that it can carry. I would be quite interested to know if there are any particular pay strategies that you think would bring that kind of person back into the industry. We hear a lot about deferral, and I would be interested to know what you think is the appropriate deferral period; we hear quite a lot about how pay should be made in rather more at-risk instruments-some say shares, and now they are talking about subordinated debt, or bail-in debt, or whatever. I would just like your thoughts on this, as I am not clear on it: how much do you think that actually changes behaviour? Some of it provides a mechanism for clawback, but given the way that people are impacted, the amount of ego involved and all those kinds of issues, is this marginal, or is it at the centre of changing the culture?

Paul Sharma: It depends what else is done. If one just addresses the technicalities of fixed and variable-the amount that is vested after the watch period or how much is cash and how much is shares-and the previous culture prevails in recruitment, promotion, appraisal, awards of increases in fixed pay and so on, I suspect that will not achieve a lot at all. There are plenty of other ways of rewarding and remunerating people, and conveying cultural messages to people, through other parts of the HR system. If, however, one addresses the structure of remuneration in the context of wider change, it will be effective and a significant, necessary and essential part-although not, of course, the entirety-of what is needed to change culture.

Q3386 Baroness Kramer: Do you have any comments on specific things such as deferral periods or different ways of paying?

Paul Sharma: The jury is out on deferral periods. The ideal thing would be to make the current minimum deferral periods work as minimum deferral periods, with firms with the right culture selecting deferral periods for individuals in particular lines of business that are appropriate to the life cycle of the businesses that they are in. If that cannot be made to work-in my view, the jury is still out on that-the question of minimum deferral periods would need to be looked at again.

Q3387 Baroness Kramer: And in terms of bail-in subordinated debt, the argument goes both ways.

Paul Sharma: There are a number of sets of technical things-for example, return on assets and bail-in debts-that are all about incentivising people vis-à-vis all the stakeholders in the bank, not just the equity stakeholders. One can debate at a technical level which is the precise technical one that should be used, but, as an objective, that is spot-on-aligning the incentives and solving the principal agency problem not just between the employees and the shareholders, but between the employees and all the stakeholders in the bank.

Q3388 Baroness Kramer: Returning to the situation that was described to us at the beginning, where risk and return were exactly aligned-

Paul Sharma: Yes, and not just risk to shareholders, but risk to all of the stakeholders. On that risk and rewards aligning, there is a danger that one does that in the wrong culture simply by increasing the risk to the individual. Actually, what we want is certain types of risk that are not healthy being removed from the system and from the individual. It cannot all be about making the individual as risky as the bank.

Q3389 Chair: More than 99% of the work force in large banks are non-coded staff.

Paul Sharma: Yes.

Q3390 Chair: Why are you concentrating on so few people?

Paul Sharma: Some of the key principles that are set forward both in European law and in our approach apply to all staff, or at least to significant levels of staff within the organisation. It is a question of two or three things coming together. First, tone at the top. You made a very good point-I forget who to; he was sitting in this chair. Is the attitude of the person whose pay you are deciding influenced by their knowing how much you are paid?

Q3391 Chair: Curiously, he found that simple question extremely difficult to understand. He needed to have it given to him on at least three occasions. That was virtually the identical wording.

Paul Sharma: He did indeed. There are other ways in which tone at the top matters in terms of what happens throughout the organisation, so I think it is right and proper that we drill down to a greater extent on a set of people who are at the top of the remuneration scale. One of the challenges for us, however, is that both the law and our own rules and practice are intended to aim at a remuneration much more widely than the code staff. Making that work more effectively in practice is one of the big implementation issues for us over the coming years.

Q3392 Chair: You said, and I agree with you-but I am struck by it-that REMCO reform is only part of the picture. In systemically risky institutions, where shareholders benefit from an implicit guarantee, do you think that they therefore owe the companies that they have bought into-in practice, it is the institutional shareholders, on behalf of the ultimate beneficiary-a duty of some type to what they have bought into? Specifically, do you think that they should take an interest in what these people sitting on these REMCO boards are doing, as they share out the profits between shareholders on the one hand and staff on the other?

Paul Sharma: Do I think the institutional shareholder should take such an interest?

Chair: Yes.

Paul Sharma: Yes, clearly they should. They are not the only ones who should take such an interest, but clearly they should.

Q3393 Chair: I just want to concentrate on those institutional shareholders for the moment. How might that be manifested? May I make a suggestion, and then you may have your own suggestion? Might it be of value if REMCO boards, which are appointed by the nominations committees ultimately, derive, via the nominations committee, from some kind of input from direct institutional shareholders, direct institutional input? For example, that a number of people on the nominations committee should be put there directly by shareholders. It would have to be the nomination committee, if you want to influence the REMCO committee.

Mr Sharma: I can see the attractiveness of that. Obviously, one wants the decision on remuneration to remain a decision that the board takes, subject to regulation, and remains responsible for. What you have described may or may not work, but something in the space that you are asking about would clearly be beneficial.

Q3394 Chair: Have you any proposals of your own to plug the gap?

Mr Sharma: No. It is a fair and good challenge-but not straight away.

Q3395 Chair: If you think of one, we are interested.

Mr Sharma: Yes.

Chair: Nigel Lawson has a rejoinder, then we are going to close.

Q3396 Lord Lawson of Blaby: I should just like to follow up on another aspect of the institutional shareholder issue. Right at the beginning of your answers, you suggested that the reason why shareholders went along with the absurd levels of pay for bank executives was that they were doing so well themselves, so they were quite happy. But, in fact, as Andy Haldane has documented, bank shareholders did not do at all well.

It has been suggested that the reason why they were useless in this regard may be because their system of remuneration was remarkably similar. The people who run the big insurance companies and venture funds, and so on, had a similar system of remuneration to the banks. Therefore they were complicit, as it were. Do you see that as a problem? If so, as the regulator do you think you need to look also at how the big institutional shareholders govern themselves?

Mr Sharma: Let me go back. There were a number of things going on with bank profitability pre the credit crunch, one of which was the farming of the economic rent from the too-big-to-fail. The other thing was the illusory profits. Andy’s work in large part goes to the point that, actually, compared to the underappreciated risk that the banks were actually taking, they were not doing so well. But that is a correct perception now, rather than the perception at the time.

Q3397 Lord Lawson of Blaby: They were not getting a huge dividend stream and bank shares were not the best shares.

Mr Sharma: Indeed. But they were getting enough to satisfy them. To answer your question, this goes to the point that, if one wants culture change, as opposed to correcting idiosyncratic problems, then there is something more than simply the scrutiny of remuneration committees or of institutional investors who share some, but not all, of the characteristics of the banks that they are investing in. Something more than that is needed.

Q3398 Chair: You have been frank and it would be helpful if you put down in writing for us to what extent you really think that a regulator can make a difference in this area.

Mr Sharma: Indeed.

Q3399 Chair: As soon as there is a problem of this type, people tend to say, "We’ll get a regulator in and he’ll sort it out for us." We need to have a clear understanding of the scope and limits of what a regulator can achieve.

Mr Sharma: Indeed.

Chair: Thank you very much, Mr Sharma. We will call an end to our session for the day.

Prepared 4th February 2013