Complex can of worms – The Investment Association urge fund managers to divulge pay practices

Photograph-by-Ian-DavidsonIntroduction
The Investment Management Association has urged its members to disclose their pay policies and how this encourages alignment between investment teams and clients. At one level this is a worthy aspiration, particularly given the recent attacks on the industry by the Institute of Directors. On the other it is a smoke and mirror exercise to hide poor practice and misaligned reward. Anyone with any knowledge of the workings of financial services reward knows that broad principals often hide dirty details at the operational level.

Complexity, culture and competition
The publishing of generic pay policies cannot reflect the necessarily complexity of remuneration structures and practice in the investment management industry. Investment and asset management is, like the majority of financial markets, heavily segmented, heavily differentiated and deeply complex, There are considerable differences between the activities of an Equity Index fund, an active bond fund, a property fund and an active emerging markets equity fund. Their risk and reward profiles are totally different as is often the time frame in which they operate, There are multiple flavours of “funds of funds” as well as cross holdings of house and non-house funds with the occasional derivative overlay. Each and every segment will have a different reward strategy, outputs and labour markets. The industry has long ago moved away from “long only” strategies to complex and hybrid mixtures of long, short, derivative and real asset funds; all with very different revenue and risk profiles,

The characteristics of retail and institutional funds can be different as are their objectives. The maturity and fund flows also add layers of complexity to structuring remuneration. Some investment funds are nearer hedge funds than the traditional investment approaches with hedge fund like carry arrangements and performance fees. No one set of remuneration principals can cover the vast array of arrangements – often set on a fund by fund basis and changed every year,

Culture
As we have learned from the history of the many investigations in to financial services malpractice; culture can play a larger role in determining behaviours, reward and performance than any set of policies. A typical example is the on-going issues with LIBOR fixing. The “nod and wink” or the tacit acceptance by senior management that certain behaviours will not be noticed if a profit is turned is as frequent in investment management as it is anywhere in financial services. The same pressures on sales and fund performance exist in this industry as it does in, say investment and corporate banking. The amounts at stake are of eye watering size. In 2013 assets under management just in the UK were £6.2 trillion and that is before the recent uptick in world stock markets. The FT estimates that an average compensation cost per employee at global asset managers is US$263,000 and is set to overtake investment banking pay by 2016.
Regulation in the sector is growing and increasingly odious. However, as history of the recent past shows, the regulators are invariably behind the curve and just do not have the intellect or resources to catch up with changing remuneration and risk profiles in fast moving, innovative financial services industries.

Competition
The competition for star players in the investment and asset management industries are just as intense as in investment banking. Individuals and teams move houses with remarkable rapidity; given the alleged longer term horizons. The facts are that performance is measure over months, quarters and annually the same as it always has been. Despite regulation, lucrative transfer terms are still a very active activity in this market place. Again, there are few star performances and everyone knows who there are. The fight to retain and recruit talent from a limited pool is one of the major drivers of remuneration in this sector. A 2013 survey by Heidrick & Struggles in late 2013 noted that:
• 41% of respondents are actively recruiting
• 57% of distribution professionals are open to considering new opportunities
• 50% of survey respondents had changed jobs in the last three years
Dated as this survey is, the trend can only be upwards given the ever increasing amount of assets under management in the global marketplace as investors scramble for return in the long-term low interest rate return environment.

The amount paid to these star players cannot be overestimated, although small in number their remuneration can add up to a considerable percentage of the employee costs of an organisation. Thus the use of averages is, like most remuneration measurement in financial services, deeply misleading. The differentiation, the complex nature of packages, the uncertain future value of compensation awarded today means that even establishing a base line is fraught with methodological difficulty.

Remuneration policies
If you wanted to be mischievous; it would be fun to play buzzword bingo with investment and asset management remuneration policies. They all want to attract, retain and reward. They all want to create shareholder value within the risk appetite of the organisation. The vast majority will pay lip service to employee behaviors and risk management as counter-balances to pure performance measurement. Frankly, I could write a remuneration policy for any of these organisations in a relatively short period of time.
These policies hide a complex reality of highly diverse practices with a dazzling array of performance metrics (often differing between individual peers in the same team) that would take an actuary to calculate the outcomes; and that is before the inevitable horse trading around what the metrics actually mean and how they should be applied.

The remuneration policy will no doubt talk of alignment of interest with clients; but what does that really mean in practice? As one large institutional investor said to me only last week; she did not really care how the return was made provided she they hit their target benchmark. Other investors will have strict ethical guidelines or even religious considerations as constraints on the activities of the managers. Thus what aligns with one client requirements will be an anathema to another. Yet it may well be the same investment manager running both funds – what then is “alignment”?

Concluding can of worms
The request made to investment managers to be more open on their remuneration is a good try but no cigar. Being pragmatic, it may be seen as a sophisticated effort to ward off yet further regulation and statutory disclosure. The reality is that, like so much remuneration in financial services any potential “truth” is deeply hidden and can only be understood by seasoned professionals and remuneration analysts and even then on the basis of numerous, conflicting assumptions.
I know from experience that the world of asset and investment management remuneration is complex as a necessity. It reflects the fragmented, segmented complex world in which these organisations flourish and make a great deal of money.
Trying to reduce the environment to the level of disclosure of remuneration policy is perhaps something of a pointless, resource wasting and ultimately a counterproductive exercise.

Rebuilding trust in the City of London

 

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Introduction

I was at a recent meeting in the City of London to launch the document “Focus on rebuilding trust in the City” a Chartered Institute of Personnel and Development (CIPD) survey of staff in financial services in the City of London on trust and their employment relationship.  (I tweeted from the meeting #rebuildtrust )  The keynote speakers to an invited audience of senior City HR people and journalists were:

 

It was an informative meeting presenting both the survey results and material on initiatives taking place to build trust after the calamities, errors, poor judgement and near criminal activity in the City over the last few years, which has badly eroded trust in what was once a gold standard for honesty and integrity.

Both Peter Cheese and Andrea Eccles gave particularly good presentations from different ends of the initiative spectrum.  Peter spoke on the big picture and in particular the role that HR has to play in leading the changes.  Andrea spoke of the very important key initiatives at grass roots level that City HR are taking, working with the Lord Mayor’s City Values forum.

The key themes during the meeting were:

Each of these themes is explored below.

Culture

Culture has been identified by the CIPD in earlier work as being fundamental to the required changes in the City.  The survey indicated clearly that the existing culture is a long way from being what is needed.  45% of the participants said their employer put profit before values.  Only 47% of staff saw customers as their key stakeholder.  As one of the speakers said, “What is required is a return to the core values of caring for customers and caring for employees”. 

One interesting take on the subject was the suggestion that financial services organisations need to focus more on recruiting “ethical” people.  My own experience, backed up by the survey results, is that a lot of people join financial services to make money.  In order to be seen as successful and to make the big bucks you need to be aggressive and egotistical; otherwise how would you make deals worth millions of pounds?  Unfortunately, aggression and egotism are not good indicators of ethical behaviour.  This goes to the heart of the matter; it is very difficult to make lots of money in an ethical and customer focused way.  The demands on one hand, by shareholders and analyst to make shed loads of money on one hand, and on the other, regulators, politicians (especially the European Union) and media on the other trying to stop profitable activity.

The role of HR in leading the changes was highlighted several times.  Again the paradox between this approach and the role of HR in supporting the business to carry out its activities was evident.  A good example was a comment about the morality of HR being involved in compromise agreements in financial services.  It was alleged that these compromise agreements can (as in the case of the NHS) be used to gag whistle blowers.  The reality is that compromise agreements are an essential part of the HR toolkit.  It allows for the amicable separation between employer and employee, normally on a “no fault” basis.  In the fast paced and rapidly changing environment like financial services, there will be differences of opinion, strategy and personality clashes.  Compromise agreements lead to a civilised and low cost way of managing these situations.  The suggestion that HR should stop using them is really throwing the baby out with the bathwater.  HR has far more important tasks in providing the frameworks for culture change than worrying about compromise agreements.  It is getting tied up in the detail rather than working on the big strategic picture that often leads to HR being perceived as a barrier rather than an enabler.

There was some good news.  RBS, the largely state owned bank in the UK, was singled out for praise for its work in introducing a much more ethical and customer centred approach – something of which I have some personal experience. (And would like to have more if Rory Tapner is reading this).  Sadly examples of good practice are few and far between. 

Values

Part of the discussion on culture must include values.  City HR is leading a lot of work on the development of toolkits to help.  The presentation by Simon Thompson went in to detail on the work of the Institute of Bankers on professional standards and many big employers in the City have signed up to these standards and the educational and training frameworks that support these approaches. 

Professionalism

This was a key theme in the presentations.  Raising the level of professionalism is very important in defeating the current broken culture.  What do I mean by broken culture?  It is the behaviours that allowed the manipulation of LIBOR rates for profit; that mis-sold products including PPI and, perhaps, some derivative products for gain rather than the good of the customer.

The survey showed that only 30% of staff are in professional bodies with standards.

To work in HR in the City you need to be CIPD qualified, yet to work as a banker you need no qualifications at all

That quote summed up for me the entire issue around professionalism.  One can argue about professionalism and its meaning.  It does normally provide a framework of acceptable (and unacceptable) behaviour that can form the basis of reward on one hand and disciplinary action on the other.

There was a comment that there are a vast number of codes of practice, regulations, laws, (domestic and foreign) and guidance – some of which is in direct contradiction.  True, but no one said it was going to be easy.

I must again praise the work of City HR in providing structure and good practice for professionals in the City.  This slow drip drip drip of information, tools and frameworks are, over the long term, likely to prove to be a bigger boost to professionalism than grand culture change initiatives by those embedded in the current City ideology. 

Leadership

One of the more disappointing results from the survey was that 41% of the participants said that there was one rule for senior management and another of other staff.   Given that nearly all the speakers emphasized the key role of senior management and CEO’s in leading the culture change; there is still a big mountain to be climbed.  The fact that only 36% of “other ranks” are aware of their organisations values indicate that organisational leadership has a large communications issue on their hands; and what is leadership if it is not communication of the vision.

Risk Management

A key theme during the presentation and during the Q&A session that followed was risk management.  It is clear that the framework to support culture changes needs good human capital measures and strong analytics.  Why?  Two major reasons were discussed.  First, it is difficult to discuss change if it cannot be properly measured.  Second, in the world of financial services number crunching and risk analysis are part of the bread and butter of daily activity.  To have credibility, the change activity, particularly if led by HR, needs to adopt this approach.  When I worked in investment banking I sat on the Operational Risk committee and that experience led directly to my design and implementation of a reward risk framework.     Exactly the same type of approach can be used when thinking about risk and culture in the financial services environment.  It is this sort of fundamental change in thinking that is going to provide the scaffold for the success of the work in culture change.  HR does, on occasion, shy away from people metrics; yet they are an essential framework for designing interventions and supporting our businesses. 

Role of HR

There was a lot of discussion on the role of HR.  Here I must depart from the gospel according to the panel speakers.  There are two places the pressure for change will come; the first is from senior management.  There is a bit of an issue with this one.  Senior management got where they are by supporting and encouraging the status quo.  Much of this has been made in management literature; the ideology of management has support for the status quo deeply imbedded within it.  Asking senior management to support massive cultural change may be like expecting turkeys to vote for Christmas….  The second place is from the employees within the organisation.    It is possible, as history has shown, for small but articulate groups of people to push for change from within the organisation.  Given the above mentioned ideology that is a possibility but not a strong probability. 

If culture change becomes another HR intervention it has the possibility to be marginalised and not become part of mainstream business thinking.  The survey showed that a number of culture change initiatives have not worked so far.  Only 17% of participants saw the culture change in their organisation as being very effective.

Clearly HR does have a role in providing the toolkits, interventions, training and development necessary to carry out the culture change; but leading it is not, in my view, going to happen and if it does it is more likely to lead to a marginalisation of the change on the business agenda as so often happens with HR led initiatives.

HR does have a key role in modelling and supporting behavioural change as well as ensuring that the new generation of bankers coming through at least start with an ethical mind-set. 

Reward issues

Reward is at the heart both of what is “bad” in the City and what will help drive change.  But,

  • 73% of staff think that some people in financial services are overpaid
  • 67% say there is secrecy around pay for senior mangers
  • Only 36% see reward as being “fair”.

As reward professionals we have to stand up and be counted.  Discussion needs to take place on what is “fair” pay.  Pay systems have to be somewhat more open so there is a greater understanding of what people are being paid for,

Key tasks include:

  • Better advocacy of pay levels and differentials in organisations
  • Development of incentives to encourage professionalism
  • Development of reward and performance management that encourage thinking about how an objective is reached as well as the measure of the objective.
  • Being as open as is appropriate to stakeholders on our reward approaches and outcomes
  • Being an advocate both internally and externally for the reward systems and outcomes.
  • To bring measured, data led, rational debate to politicians, the media and other commentators to prevent or at least moderate the near hysteria around financial services and senior executive pay

Conclusion

The CIPD report is a timely looking glass in to the views of those who work in financial services as to issues of trust and reward.  It is well written and influential; I would recommend it to you. (Disclosure note; I undertook some analysis of the raw data in the report for the CIPD).  Both the CIPD and CityHR are clearly thought leaders in this field and their activities are to be applauded.  The report is an important part and input to the on-going discussion on this subject.

The report is also timely.  The results from the Banking Standards Inquiry by the UK’s House of Commons are due to be produced very soon.  Unfortunately it may be argued by some that it has been badly tainted even before release because:

  • The standards of politicians in the UK are at an all-time low and lecturing other people on ethics and standards is at best the pot calling the kettle black and at worst rank hypocrisy.
  • A lack of understanding of the world and work of financial services by MP’s who have seldom operated in the real world and those who have did so via the playing fields of Eaton (an elite fee paying school in England  attended by many of the UK cabinet and their advisors).
  • A large part of the problems with the collapse of trust in financial services is due to inaction by politicians and regulators who believed that light touch and not actually understanding what was going on was a good way to regulate a very complex, risky, global business.
  • A potential perception that there is a lot of band-standing and jealousy going on at Westminster village that does not aid credibility

I hope I am wrong and wait to read the report with interest.  However, the weight of history is against them; since when have politicians made anything better?

Failure is not an option unless we do want the politicians to bring their incredibly costly sledge hammers to smash some nuts that, it turns out on closer inspection, actually have nothing to do with the problem.

It is only by hard work based on sound data such as the CIPD report; and not taking some moral high ground and seeking to apportion blame; that will make the very necessary changes.  HR and reward in particular do have key roles to play.  At the end of the day there must be the drive and will in the Board room to make the required culture change a reality. 

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