Blog : BOARD TALK
|Posted on June 19, 2015 at 4:20 PM|
Juliette Graham, Linklaters Employment & Incentives Lawyer
"The penalties aren't enough... Cultural change - that's really the aim of this - not to send people to jail" Martin Wheatley, CEO of the Financial Conduct Authority (FCA), said of the Fair and Effective Markets Review (FEMR) Report published last week. The Report is a wholesale assessment of the Fixed Income, Currency and Commodities (FICC) markets which in recent years have been involved in LIBOR and FX manipulation cases amounting to billions of pounds in fines.
But how does a regulator affect cultural change? The Report offers a number of ideas with this ambitious aim underpinning its major recommendations. Two key recommendations relate to remuneration and criminal sanctions.
The structure of remuneration and whether it incentivises individuals to take excessive risk has been a key issue for regulators since the G20 met in the aftermath of the financial crisis to endorse the Financial Stability Board’s remuneration report. FEMR now wants this same body to further examine the alignment between remuneration and conduct risk at a global level. FEMR is concerned by the recent increase in fixed pay, and think that more could be done to integrate conduct risk into firms’ remuneration decisions, perhaps by debt structures forming remuneration packages rather than cash and equity.
A return to increased variable remuneration would most likely be welcomed by firms given that fixed remuneration is guaranteed regardless of individuals’ performance and increases firms’ fixed cost bases making them harder to adjust in times of stress. However, the Report does not promise the period of consolidation that so many in the industry hoped for.
If the regulators mandate a portion of remuneration to be linked to debt, firms will have the difficulty of redesigning their incentive schemes to comply with regulation, communicating such changes to employees (whilst still competing in a global market for talent), and operating such schemes effectively (often within large international organisations subject to complex legislation).
Pending the findings of the Financial Stability Board, firms should review the terms of their fixed allowances to ensure that they can be amended to reflect changes in regulation and law, and ensure that conduct risk is integrated into their remuneration decision making process.
If remuneration is the ‘carrot’ then criminal and civil sanctions are the ‘stick’ and the Report makes a number of recommendations in this field. It asks for the market abuse framework to be broadened to cover a wider range of FICC instruments, for the maximum sentence for criminal market abuse to be extended from seven to ten years imprisonment, and for a new statutory civil and criminal market abuse regime to be created for spot foreign exchange.
This no doubt reflects the regulator’s frustration that with the recent manipulation cases, firms have been fined, but it has proved difficult to prosecute individuals for their actions. If these recommendations are implemented, individuals’ minds will once more be focused on the importance of understanding and complying with the UK criminal regime, and the onus will be on firms to provide adequate training and support in this area.
It is interesting that within the context of increased individual accountability, FEMR did not think it proportionate when recommending the extension of elements of the Senior Managers and Certification Regime to FICC market participants to include the ‘reverse burden of proof’.
The reverse burden of proof allows regulators to take action for misconduct against a senior manager if there are regulatory breaches in their respective area and they are unable to demonstrate that they took reasonable steps to prevent such breaches. Perhaps FEMR’s focus was on the scope of criminal sanctions rather than civil sanctions to which the ‘reverse burden of proof’ relates.
The Report makes a number of proposals, and just a few have been mentioned here. But the key takeaway is that management need to set the tone at the top, have full oversight of its business, and ensure that employees comply with the rules."