New Rules Regulating Compensation Ahead

2-Jan web article hutterstock_70271320

The UK Central bank leads the pack in CRD IV compliance.

The 2008 financial crisis wasn’t just a problem at home. It was a global crisis and the major powers were moved to action. The US reaction was to pass the Frank-Dodd Act in July of 2010, and the EU’s Basel Committee on Banking Supervision (BCBS) went to work on their own solution. Out of the efforts of the BCBS came Basel III. One goal of Basel III was to ensure that EU banks increase their liquidity, and decrease their leverage. In July of 2010 the committee finalized their proposals and in November of 2010 the G20 endorsed them. While the Frank-Dodd Act was to become law in the US, the recommendations of the BCBS are just that – recommendations. However, it is expected that each G20 country will pass laws or regulations to implement Basel III by a deadline of January 1, 2019.

Basel III recommendations were split into two parts: the Capital Requirements Regulation (CRR), and the Capital Requirement Directive IV (CRD IV). CRD IV introduces additional transparency and disclosure requirements for certain individuals who earn more than $1M € ($1.3M USD, as of this writing). The target of the measures are individuals whose activities have an impact on their organization’s risk profile, specifically Senior Management and “risk takers”. Financial Advisors are considered to fall under the “risk taker” designation. Basel III proposed to regulate bonus and salary, with a ratio of 1:1 respectively. And the ratio would never be more than 2:1, but raising the ratio needs to go to the shareholders for a vote.

The US is a member of the G20 and it’s reasonable to expect that by January 2019 the remuneration proposals of Basel III will become at least part of the conversation stateside. Broker compensation in the States has long been a bone of contention. Commission-based Financial Advisors believe they deserve a larger percentage of the fees paid to the firms. Private Bankers are compensated on a salary/bonus basis, with a bonus generally paid once or twice a year, and tied to firm performance. Advisors who earn a percentage of T-12 can significantly affect the firm’s cash flow, especially in a volatile market. The cash flow and liquidity of the banks at any given time is believed to have been a large contributor to the 2008 major meltdown. The Basel requirements attempts to address and rectify capital issues through its proposals and target compensation model.

The largest expense for most banks is compensation, and limiting all risk takers to a salary/bonus model of 1:1 would fix some of those expenses and cap others. This remuneration model would have a substantial positive impact the firms’ capital, allowing them to do business as usual without fairly compensating Advisors for their hard work. Banks are already looking for ways not to pay Advisors. There is widespread support for FINRA’s Broker Compensation Disclosure rule, which would mandate that each and every client receive a disclosure letter from a hiring firm ‘disclosing’ the granular financial details an Advisor was paid to move. We see this impacting deals significantly in a negative way.

The Brits have taken the lead and passed laws to comply with Basel. It’s not a matter of will the US and the rest of the European firms follow, it’s more a matter of when. The G20’s stamp of approval on Basel is just another way to take money out of the Advisors’ pockets. It won’t be tomorrow, but expect to see significant compensation changes over the next five years.