On 20 November 2024, the Financial Stability Board (FSB) issued a report ‘Legal and regulatory challenges to the use of compensation tools’.

The report identifies potential ways to address challenges in the use of compensation tools and follows guidance that the FSB published in 2018 on the use of compensation tools to address misconduct. Since March 2021, several jurisdictions have implemented legal and regulatory changes related to the use of compensation tools. The lessons from the 2023 banking failures reinforced the lessons from the global financial crisis: compensation must be aligned with prudent risk-taking.

The report notes that consistent with previous FSB compensation progress reports, there is complexity and variability in implementing different compensation tools. In-year adjustments are relatively straightforward to implement, whereas malus and clawback provisions present varying degrees of challenges. Clawback provisions are difficult to enforce and often involve prolonged legal battles, especially in the United States and Europe, where cultural or legal hurdles complicate their application. In some jurisdictions restrictive labour laws prevent clawback being applied.

The report highlights a number of practical solutions to addressing challenges experienced by jurisdictions and firms applying compensation tools. These centre around four key themes: the role played by the board, the importance of culture, the importance of transparency and the role of financial authorities.

In relation to the board, the report notes that the board, including the remuneration committee, play a crucial role in establishing compensation frameworks that drive the desired risk culture. Boards must also be willing to discharge their responsibilities to apply compensation tools where risk incidents occur, based on appropriate risk reporting from sources such as the Chief Risk Officer and Risk Committee. Many of the challenges in the use of compensation tools can be overcome through uplifting and enhancing compensation practices (for example, clear risk triggers for each tool).