The proposed extension of the rules on remuneration for bank staff to non-banking firms has created confusion and left many firms up in arms.
The new rules would mean firms such as asset managers would have to be run under the same strict legislation that has been forced on banks in the wake of the banking crisis.
But having sat through the FSA’s asset management conference recently, I am left with the impression the FSA is more than likely to alter its stance on the application of these standards to non-banks.
Following the banking crisis, the G20 was quick to agree that rules should be put in place to make sure the capital position of the banks was satisfactory. Now the FSA wants to apply the same rules to investment firms. But forcing non-banks to adhere to the same standard does not make sense and risks making the UK a less attractive base for asset management businesses.
The FSA has suggested that the proposed extension of the rules emanated from Capital Requirements Directive amendments – which support the G20 commitments – and the apparent need to address the competitive implications of applying the code differently between banks and other investment firms.
The EU suggests introducing the principles that applied to banks from last year to all Mifid investment firms. Those principles include risk management, risk tolerance, a code supporting long-term business strategy, addressing conflicts of interest, ensuring appropriate governance and that the total variable part of remuneration does not limit a firm’s ability to strengthen its capital base. These high principles make sense only if implemented proportionately.
The UK regulatory body proposes the extension of the code on the basis that if it did not apply it to all firms unilaterally there would be competitive pressures for individuals to move from firms covered by the rules to those that were not, resulting in a potential transfer of risk.
There may be very good arguments for this point in limited circumstances but, not withstanding the proportionality provisions in the code, there are likely to be more measured approaches than applying blanket minimum requirements – designed with banks in mind – to firms that do not have comparable risk characteristics, fundamental structures or size.
In our initial review of the consultation paper, we concluded the proposals were unworkable for the majority of institutions not set up as banks and we hope consultation at an industry level will work to address inconsistencies between the international principles and the proposed code.
The FSA, in trying to be the first mover in changes to the regulation, came out with specific rules that would apply to all firms affected by MiFID.
However, the European consultative document used to justify the extension of the code, which refers to the international principles as laid down by the Financial Stability Board, highlights the obligation as restricted to people who can affect the risk profile of the bank or investment firm.
Furthermore, it is made clear in the supporting documentation that this refers to people who take decisions that affect the risk profile of the institution in the context of the capital adequacy of the institution.
This differentiates the application of the policies between firms that take on balance sheet risk and those considered to be intermediaries.
The EU proposals accept that credit institutions and investment firms conduct different activities and have different levels of tolerated risk, meaning policies must be drafted accordingly. In addition, the FSA proposals attempt to equate the level of risk and proportionality to the amount of remun-eration received.
Many investment managers, who under current require-ments relating to alignment risk operate a policy of requiring managers to invest in their own funds, have suffered along with their investors in the recent credit crisis.
For the smaller absolute return funds in particular, managers invested their own money and have lost out due to both market depreciation and lack of performance receipts as a result of high water marks. I suspect those managers, who up to recently have been incorrectly blamed for the crisis, may have reacted negatively when they learnt of the extent and implications of these proposals.
However, some industry experts are saying that because of the way it may be applied to other firms unable to absorb a tax deferral, individuals earning money that would have to be deferred over three years could be forced to pay all the tax in the first year, irrespective of when it becomes vested.
At the asset management conference, in response to the many concerns raised, we were reminded that a lot of the rule-making has been transferred to Europe and the FSA needs to have a strong position at the EU negotiating table.
The proposals show a lack of understanding as to how the UK industry operates and could make it harder to attract and retain talent. The FSA has inadvertently signalled it is taking a less consultative approach to the industry. But the message now is that this was not its intention.
It has been suggested that the FSA has put forward specific proposals before Europe as a whole had a chance to agree the principles with its regulatory partners. We need the whole of Europe and the G20 to agree the principles before the details are put in place. Otherwise, we are in danger of seeing business creeping away from the UK into other business-friendly jurisdictions, which will provide the service on a cross-border basis. This will ultimately harm the UK taxpayer.
It is hoped the FSA rules will be published in November with implementation by January 1, 2011. The regulator has accepted, however, that certain aspects of the code cannot apply to particular structures of firm and has proposed to allow a further six months for the FSA to work out how it will apply to those. In the meantime, firms will be required to have some sort of code and work out how this will be operated.